Introduction to Business Accounting

INTRODUCTION TO ACCOUNTING
Jacqueline Peters-Richardson

Course Name – Introduction to Accounting
Course Author - Jacqueline Peters-Richardson, Ministry of Education, Trinidad and Tobago
Commonwealth of Learning
Edition 1.0

____________________

Commonwealth of Learning ©September 2011
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Introduction to Accounting Page | 1

ACKNOWLEDGEMENTS

The Commonwealth of Learning wishes to acknowledge the contributions of the course
authors and the support of the University of Lesotho in the creation of this course.


TABLE OF CONTENTS
ACKNOWLEDGEMENTS ................................................................................................................................. 2
COURSE OVERVIEW....................................................................................................................................... 6
Introduction .............................................................................................................................................. 6
Course Goals ............................................................................................................................................. 6
Course Structure ....................................................................................................................................... 7
Required Readings .................................................................................................................................... 7
Assignments and Projects ......................................................................................................................... 8
Assessment Methods ................................................................................................................................ 8
Time Required ........................................................................................................................................... 8
Course Schedule........................................................................................................................................ 8
STUDENT SUPPORT ....................................................................................................................................... 9
Academic Support ..................................................................................................................................... 9
How to Submit Assignments ..................................................................................................................... 9
Technical Support ..................................................................................................................................... 9
UNIT ONE – INTRODUCTION TO ACCOUNTING .......................................................................................... 10
Unit Introduction .................................................................................................................................... 10
Unit Objectives ........................................................................................................................................ 10
Unit Readings .......................................................................................................................................... 10
Assignments and Activities ..................................................................................................................... 10
Topic 1.1 Definition Of Accounting And Accounting Terms.................................................................... 11
Topic Summary ....................................................................................................................................... 17
Topic 1.2 The Accounting Cycle .............................................................................................................. 18
Topic 1.3 Business Accounting Process And Procedures ........................................................................ 22
Topic 1.4 The Accounting Equation And Balance Sheet ......................................................................... 26
Unit References....................................................................................................................................... 32
Unit Summary ......................................................................................................................................... 33
Unit 1 Suggested Answers ...................................................................................................................... 35


UNIT TWO – DOUBLE ENTRY SYSTEM OF ACOUNTING .............................................................................. 37
Introduction ............................................................................................................................................ 37
Objectives ............................................................................................................................................... 37
Unit Readings .......................................................................................................................................... 37
Topic 2.1 Books Of Original Entry ........................................................................................................... 38
Unit Assignment ...................................................................................................................................... 57
Topic 2.2 Recording Business Financial Transactions ............................................................................. 58
Unit Assignment ...................................................................................................................................... 75
topic Summary ........................................................................................................................................ 75
Topic 2.3 Balancing Off Accounts............................................................................................................ 76
Topic 2.4 Trial Balance ............................................................................................................................ 81
Unit Summary ......................................................................................................................................... 83
UNIT THREE – FINANCIAL ACCOUNTING AND ADJUSTMENTS ................................................................... 85
Unit Readings .......................................................................................................................................... 85
Topic 3.1 Depreciation And Disposal Of Assets ...................................................................................... 86
Topic 3.2 Adjustments For Financial Reporting ...................................................................................... 97
Topic 3.3 Bad Debts And Provision For Bad Debts................................................................................ 102
Topic 3.4 Inventory Accounting ............................................................................................................ 109
Topic 3.5 Final Accounts for Sole Trader .............................................................................................. 113
Unit Summary ....................................................................................................................................... 122
UNIT FOUR – ANALYSING/INTERPRETING FINANCIAL STATEMENTS AND CONTROL SYSTEMS ............... 123
Introduction .......................................................................................................................................... 123
Objectives ............................................................................................................................................. 123
Unit Readings ........................................................................................................................................ 123
Assignments and Activities ................................................................................................................... 123
Topic 4.1 Accounting Ratios .................................................................................................................. 124
Topic 4.2 Correction of Errors ............................................................................................................... 130
Topic 4.3 Payroll .................................................................................................................................... 137
Topic 4.4 Bank Reconciliation Statement ............................................................................................. 144
Topic 4.5 Petty Cash Book And The Imprest System ............................................................................ 150


Topic 4.6 Control Accounts ................................................................................................................... 155
Unit Summary ....................................................................................................................................... 159
UNIT FIVE – FINANCIAL STATEMENTS OF OTHER ORGANIZATIONS ......................................................... 160
Unit Introduction .................................................................................................................................. 160
Unit Objectives ...................................................................................................................................... 160
Unit Readings ........................................................................................................................................ 160
Assignments and Activities ................................................................................................................... 160
Topic 5.1 Single Entry And Incomplete Records ................................................................................... 161
Topic 5.2 Receipts And Payments Account ........................................................................................... 165
Topic 5.3 Partnership Accounts ............................................................................................................ 169
Topic 5.4 Company Accounts ................................................................................................................ 174
Unit References..................................................................................................................................... 179
Unit Summary ....................................................................................................................................... 180
FINAL ASSIGNMENT/PROJECT............................................................................................................... 181
COURSE SUMMARY............................................................................................................................... 182


COURSE OVERVIEW

INTRODUCTION
This course is designed to teach you the “language of business” to create a better
understand of the terms and concepts used in business decisions. The course Introduction
to Accounting prepares entrepreneurs to manage the financial aspects of their businesses.
In order for any entrepreneurship business to be successful there should be proper financial
recording and management of the business finances. During this course you will be
exposed to financial terms and concepts to proper financial control of your business. The
Introduction to Business Accounting course will provide future entrepreneurs with basic
skills and knowledge required to establish and maintain business accounts, read and
interprets financial reports and returns. You will explore the process and procedures of
business accounting and its role in establishing and managing a successful business venture.
You will also analyse and interpret final accounts of different forms of business.

COURSE GOALS
Upon completion of the Introduction to Business Accounting you should be able to:
1. Define accounting and accounting terms
2. Appreciate the differences between bookkeeping and accounting
3. State and illustrate the accounting cycle
4. Describe the different types of accounts
5. Examine the concepts and best practices of business accounting
6. Record and interpret entries in the books of original entry
7. Transfer information from the books of original entry to the ledgers
8. Generate trial balance from the balances in the ledgers
9. Analyse financial reports and returns
10. Calculate equity rations
11. Explain cash flow
12. Prepare bank reconciliation statements
13. Calculate payroll documents
14. Prepare cash flow, financial statements, income statements and balance sheets
15. Prepare final accounts for other forms of businesses
16. State the basic accounting equation
17. Describe the relationship between the accounting equation and the balance sheet


COURSE STRUCTURE
This course is divided into five units:

Unit One – Introduction to Accounting
Topic 1 Definition of Accounting and key accounting terms.
Topic 2 The Accounting Cycle.
Topic 3 Business accounting process and procedures.
Topic 4 The Accounting Equation and the Balance Sheet.

Unit Two – Double Entry System of Accounting
Topic 1 Source Documents and the Books of original entry
Topic 2 Recording Business Financial Transactions
Topic 3 Balancing Off of Accounts
Topic 4 The Trial Balance

Unit Three - Financial Accounting and Adjustments
Topic 1 Assets Disposal and Depreciation
Topic 2 Adjustments for financial Reporting
Topic 3 Bad Debts and Provision for Bad Debts
Topic 4 Inventory Accounting
Topic 5 Prepare Cash Flow, Financial Statements, Income Statements
and Balance Sheets for Sole Trader

Unit Four - Analysing and Interpreting of Financial Statements and Control Systems
Topic 1 Accounting Ratios
Topic 2 Correction of Errors
Topic 3 Payroll
Topic 4 Bank Reconciliation Statements
Topic 5 Petty Cash Book and Imprest System
Topic 6 Control Accounts

Unit Five - Financial Statements of other organizations
Topic 1 Single Entry and Incomplete Records
Topic 2 Receipts and Payments Accounts
Topic 3 Partnership Accounts
Topic 4 Company Accounts

REQUIRED READINGS
The institution and instructor delivering the course will identify specific readings to support
the course. Below is a list of online ebooks that could be used to support this course.

Taylor, P. (2008). Book-Keeping and Accounting for the Small Business. How to Books. (E-
Book). Available at: http://www.e-booksdirectory.com/details.php?ebook=2188

Wlather, L.M. (2001). Principles of Accounting. Principlesofaccounting.com. (E-Book).
Available at: http://www.e-booksdirectory.com/details.php?ebook=2910


ASSIGNMENTS AND PROJECTS
You will be provided detailed instructions for your final project by your instructor. Ideally
the final project for this course will require you to prepare final accounts for a sole trader
from a list of transaction and source documents. The course has been designed to provide
your guidance and activities that will prepare you to complete the final project assigned by
your instructor.

ASSESSMENT METHODS
Assessments will take the form of responding to activities, as well as coursework
assignments and a final project and examinations as determined from time to time by the
institution. In cases where coursework, assignments, projects and examinations are used in
combination, percentage rating for each component will be communicated to you at the
appropriate time. Your instructor will provide you with guidance on how he or she will
grade and provide feedback re: all graded activities.

TIME REQUIRED
The course is worth 14 credits, and each credit is equivalent to 10 notional hours. You are,
therefore, advised to spend not less than 140 hours of study on this course. The notional
time includes:
• Going over activities embedded in the study material
• Peer group interaction (where necessary)
• Face-to-face tutorials (where necessary)
• Working on tutor-marked assignments
• Preparing and sitting examinations (where that is required)

COURSE SCHEDULE
The institution and instructor will provide a specific schedule to guide students.


STUDENT SUPPORT
Note: This section should be customized by the institution delivering the course. Some
suggestions for content are provided in the heading below.

ACADEMIC SUPPORT
<Insert the following information if relevant>

How to contract a tutor/facilitator (Phone number, email, office hours, etc.).
Background information about the tutor/facilitator if he/she does not change
regularly. Alternatively provide a separate letter with the package describing your
tutor/facilitator’s background.
Description of any resources that they may need to procure to complete the course
(e.g. lab kits, etc.).
How to access the library (either in person, by email or online).

HOW TO SUBMIT ASSIGNMENTS
<If the course requires that assignments be regularly graded, then insert a description of
how and where to submit assignments. Also explain how the learners will receive
feedback.>

TECHNICAL SUPPORT
<If the students must access content online or use email to submit assignments, then a
technical support section is required. You need to include how to complete basic tasks and
a phone number that they can call if they are having difficulty getting online>.


UNIT ONE – INTRODUCTION TO ACCOUNTING
UNIT INTRODUCTION
In order for any business to be successful, there should be proper control of its finances. In
this unit you will begin by understanding basic accounting terms and principles that will get
you started to proper financial control of your business.

UNIT OBJECTIVES
Upon completion of this unit you should be able to:

1. Define Accounting and Accounting terms
2. Appreciate the difference between bookkeeping and accounting
3. State the main purpose of accounting
4. Describe the different types of accounts
5. Identify different types of business
6. State and illustrate the accounting cycle
7. Examine the concepts and best practices of business accounting
8. Identify users of accounting information
9. Distinguish between financial and management accounting
10. Examine accounting assumptions, principles and conventions and how they are
used
11. State the accounting equation
12. Describe the relationship of the accounting equation and the balance sheet
13. Understand what is meant by assets, liabilities and owners’ equity

UNIT READINGS
The instructor will provide a list of readings.

ASSIGNMENTS AND ACTIVITIES
The instructor will provide guidance on the type of assignments and instructions.


TOPIC 1.1 DEFINITION OF ACCOUNTING AND ACCOUNTING TERMS
TOPIC INTRODUCTION
We will begin by taking and look at the definition for accounting and some accounting
terms. As you have increase knowledge of various accounting terms it will enable you to
analyze and interpret the accounting records of your business.

TOPIC OBJECTIVES
Upon completion of this topic you should be able to:

1. Define accounting and accounting terms
2. Appreciate the difference between bookkeeping and accounting
3. State the purpose of accounting
4. Identify users of accounting information
5. Identify different types of businesses
6. Distinguish between Financial and Management Accounting

WHAT IS BOOKKEEPING?
Let us begin this unit by defining two important terms in accounting: bookkeeping and
accounting.

Activity 1 – A

From your knowledge of accounts what would be your define of

Bookkeeping ____________________________________________________________

_______________________________________________________________________

Accounting _____________________________________________________________

_______________________________________________________________________

Great start! Now let us look at these definitions

Bookkeeping is defined as concerned with the recording of business data. “It is the
process of recording the business transactions and the relations between the
transactions. The process of bookkeeping is mainly mechanical and does not
require any analysis. Instead of the analyzing, the bookkeeping relies only on the
recording of the information”. (difference between 2001)


Accounting is concerned with the design, interpretation of data and the preparation
of financial reports. “Accounting is also the systematic recording of business
transactions but it includes additional reports and further financial analysis of the
transactions. Accounting is also the systematic recording of business transactions
but it includes additional reports and further financial analysis of the transactions”.
(difference between 2001)

As you can see, accounting is made up of two elements:
1. Recording business transactions - Book keeping
2. Presenting the information

DIFFERENCE BETWEEN BOOKKEEPING AND ACCOUNTING
Now that we have defined both bookkeeping and accounting we can now look at the
difference between them. Bookkeeping is a part of the accounting process that records the
financial transactions. Accounting takes the recorded financial transactions entered by a
bookkeeper and prepares financial statements, liabilities of the assets and the various
results of the whole business. The accounting process uses the bookkeeping information,
interprets the financial data of the business and compiles it into reports in a format that
business managers can use to judge the financial health of the business based on their
projected financial plan.

Bookkeeping is simply the recording of monetary transactions of a business, whereas
accounting allows a business to record, analyse and retrieve critical financial information
that can be used to determine a business financial status and provide reports and insights
needed to make sound financial decisions.

PURPOSE OF ACCOUNTING
The purpose of accounting is to provide a means of recording, reporting, summarizing and
interpreting economic data.

“The primary purpose of accounting is to identify and record all activities that
impact the organization financially. All activities, including purchases, sales, the
acquisition of capital and interest earned from investments, can be classified in
monetary terms and posted to a specified account as an accounting record.
These transactions typically are recorded in ledgers and journals and are part of
the process known as the accounting cycle.” (ehow 1999-2001)

TYPES OF ACCOUNTING INFORMATION
An accounting information system provides data to help decision makers both outside and
inside the business. Decision makers outside the business are affected in some way by the
performance of the business. Decision makers inside the business are responsible for the
performance of the business. For this reason, accounting is divided into two categories:


financial accounting for those outside; and
managerial accounting for those inside.

MANAGEMENT ACCOUNTS
Management accounting refers to the processes and procedures implemented for internal
decision making and reporting within an organization. It provides information that is useful
in running a business by internal users, usually accomplished through custom designed
reports. These are produced as often as a business wants them (usually monthly). They
can be prepared using the business’s own internal policies and bookkeeping/financial
management system. Internal users, Senior and middle Management use accounting
information to run business. Employees utilize accounting information to determine a
business’s profitability and profit sharing.

Management account information or reports should:

Relate to the part of the business for which the manager is responsible. For
example, a Production Manager wants information on costs of production but not
on advertising.
Involve planning for the future. For instance, a budget would show financial plans
for the coming year.
Meet two tests:
o the accounting information must be useful and relevant; and
o it must not cost more to gather and process than it is worth.

Managerial accounting generates information that managers can use to make sound
decisions. The four major types of internal management decisions are:

1. Financial Decisions—determine what amount of capital (funds) are needed to run
the business and whether to secure these funds from owners or creditors. In this
sense, capital means money used by the business to purchase resources such as
machinery and buildings and to pay expenses of conducting the business.
2. Resource Allocation Decisions—identify how the total capital of a business is to be
invested, such as the amount of machinery to be purchased in any one year.
3. Production Decisions—decides what products are to be produced, by what means,
and when.
4. Marketing Decisions—establishes selling prices and advertising budgets;
determining the location of a business's markets and how to reach them.

FINANCIAL ACCOUNTS
Financial accounting refers to the fundamental guidelines, polices, procedures and
regulations mandated by the General Accepted Accounting Principles (GAAP), which was
established by the Financial Standards Board (FASB) and/or government regulators. It
provides information designed to satisfy the needs of external users. This reporting is done


in the form of financial statements. These accounts are usually produced annually. They
are based on historical information and are rarely used internally. Financial accounts are
used by external users for several reasons.

The external users of accounting information fall into six groups; each has different
interests in the business depending on how you are financially structure and thus will want
answers to unique questions. The groups and some of their possible questions are:

Owners and Prospective Owners. Has the business earned satisfactory income on
its total investment? Should an investment be made in this business? Should the
present investment be increased, decreased, or retained at the same level? Can
the business install costly pollution control equipment and still be profitable?
Creditors and Lenders. Should a loan be granted to the business? Will the business
be able to pay its debts as they become due?
Employees and their Unions. Does the business have the ability to pay increased
wages? Is the business financially able to provide long-term employment for its
workforce?
Customers. Does the business offer useful products at fair prices? Will the business
survive long enough to honour its product warranties?
Governments. Is the business, such as a local public utility, charge a fair rate for its
services? How much tax does the business owe?
The General Public. Is the business providing useful products and gainful
employment for the local citizens without causing serious environmental problems?


Activity 1 – B

Complete the illustration below to demonstrate your understanding of the types of
accounting and the users of the accounting information using examples.

Were you able to complete the diagram above with the correct information? Now that you
have distinguished between management and financial accounting and there users lets now
look at the different types of account.

CLASSIFICATION OF ACCOUNTS
An 'account' is a specific location for recording transactions of a like kind. The dual aspect of
treating each transaction is then recorded in an account. An account shows us the
'history' of a particular business transaction.

Accounts can be divided into three categories:

1. Personal Accounts – these are the accounts of your creditors (accounts payable) and
debtors (accounts receivable)
2. Real Accounts – are your tangible and intangible assets
3. Nominal Accounts – these are income and expense accounts of your business


Type Represent Examples
Personal Accounts related to individuals, Individuals; partnership firms; corporate
firms, organizations, or companies entities; non-profit organizations; any
local or statutory bodies including
governments at the country, state or
local levels
Real Accounts related to assets of a Tangibles – Plants and
tangible or intangible nature machinery, furniture and
fixtures, computers and
information processing
equipment
Intangibles – Goodwill, patents,
copyrights, trademarks

Nominal Temporary income and Sales, purchases, utilities, dividends
expenditure accounts for
recognition of the implications of
financial transactions during each
fiscal term till finalization of
accounts at term end
Table 1.1

Accounts can be further divided into five types. The basic types of accounts are:

1. 'Assets:' items of value that the business owns or has rights to. Examples include:
cash, real estate, equipment, money or services that others owe you (accounts
receivables), and even intangible items such as patents and copyrights.
2. 'Liabilities:' obligations that are owed to other parties (accounts payables).
Examples include: wages payable, taxes due, and borrowed money (also called
debt).
3. 'Equity:' the ownership value of a business. It is the investment by an owner in the
business.
4. 'Revenues:' the mechanisms where income enters the business (note that revenue
and income is not the same thing--they are used here to describe each other in basic
terms only. This will be explained later).
5. 'Expenses:' the costs of doing business. Examples include: salary expense, rent,
utilities expense, and interest on borrowed money.

We have now identified the different types of accounts for a business but do you know
what a business is? Let’s explore this concept.


WHAT IS A BUSINESS?
A business can be defined as a commercial organisation, which exists with a view to making
a profit. A business will generally fall into one of the following categories (depending on
the country you are establishing the business):

Sole Trader - This is a business that is owned and operated by one person. He or
she is solely liable for all business debts but when successful, takes all the profits.

Partnership - This type of business is owned by several individuals, some of which
will actively be involved in the business.

Companies (or Public Corporations) - This type of business is owned by
shareholders and is operated on their behalf by a nominated board of directors.

Non-Trading Organisations (or Non-Profit Corporations) - Clubs, associations and
other non-profit-making organisations are normally run for the benefit of their
members to engage in a particular activity and not to make a profit. Their financial
statements will take the form of income and expenditure accounts.

Cooperative Society - A legally constituted business entity formed for the explicit
purpose of furthering the economic welfare of its members and that of the wider
society by providing them with goods or services.

TOPIC SUMMARY
You just had your first insight of an operation of a business. You have distinguished
between bookkeeping and accounting, management and financial accounting and you have
also looked at the classification and types of accounts and forms of business entities.

We will now look at the Accounting Cycle.


TOPIC 1.2 THE ACCOUNTING CYCLE
TOPIC INTRODUCTION
We are now moving on to the accounting cycle. This is a series of steps that are repeated
ever reporting period. The process starts with making accounting entries for each
transaction and goes through closing the books. This is the name given to the collective
process of recording and processing the accounting events of a business. It is a methodical
set of rules to ensure the accuracy and conformity of financial statements.

TOPIC OBJECTIVES

1. State and explain the steps in the accounting cycle
2. Illustrate the accounting cycle in the form of a diagram

STEPS IN THE ACCOUNTING CYCLE
The accounting cycle is a series of steps that is followed to ensure that the records of a
business are true and fair. Each business transaction goes through these steps. Let’s have a
look at these steps in detail.

1. collecting &
analyzing
source
documents
9. Post Cloisng 2. Journalizing
Trial Balance Transactions

8. Closing 3. Post to the
Entries Ledgers
Accounting
Cycle

7. Financial 4. Unadjusted
Statemtents Trial Balance

6. Adjusted Trial 5. Prepare
Balance Adjustments


Step 1 - Collecting and analyzing data from source documents.

When a transaction occurs, a document is produced. Most of the time, these documents
are external to the business (e.g. purchase orders, sales slips, etc.), however, they can also
be internal documents, such as inter-office sales, cheques, bills from providers, etc. These
documents are referred to as source documents. Some additional examples of source
documents include:

The receipt you get when you purchase something at the store.
Interest you earned on your savings account which is documented in your monthly
bank statement.
The monthly electric utility bill that comes in the mail.
The telephone bill.
Invoices from other service providers, contractors, etc.

Step 2 – Journalizing transactions.

The source documents are recorded in a Journal. This is also known as a book of first entry.
The journal records both sides of the transaction recorded by the source document. These
write-ups are known as Journal entries.

Step 3 – Post to the Ledgers.

The Journal entries are then transferred to a Ledger. The group of accounts (described
earlier) is called ledger. A ledger is also known as a book of accounts. The purpose of a
Ledger is to bring together all of the transactions for a similar activity. For example, if a
business has one bank account, then all transactions that include cash would then be
maintained in the Cash Ledger. This process of transferring the values is known as a
posting.

Once the entries have all been posted, the Ledger accounts are added up in a process called
Balancing. Balancing implies that the sum of all Debits equals the sum of all Credits.

Step 4 – Unadjusted Trial Balance.

A particular working document called an unadjusted trial balance is created. This lists all
the balances from all the accounts in the Ledger. Notice that the values are not posted to
the trial balance, they are merely copied.

At this point accounting happens. The accountant produces a number of adjustments,
which make sure that the values comply with accounting principles. These values (such as
depreciation of equipment) are then passed through the accounting system resulting in an
adjusted trial balance. This process continues until the accountant is satisfied.


Steps 5 – Prepare adjustments.

Period-end adjustments (usually quarterly) are required to bring accounts to their proper
balances after considering transactions and/or events not yet recorded. Under accrual
accounting, revenue is recorded when earned and expenses when they are incurred. An
entry may be required at the end of the period to record revenue that has been earned but
not yet recorded on the books. Similarly, an adjustment may be required to record expense
that may have been incurred but not yet recorded.

Step 6 – Prepare an adjusted trial balance.

This step is similar to the preparation of the unadjusted trial balance but this time the
adjusting entries are included. Correction of any errors must be made.

Step 7 - Prepare Financial Statements.

Financial statements are drawn from the trial balance and are presented in the following
forms:

Income statement: prepared from revenue, expenses, gains and losses
Balance sheet: prepared from assets, liabilities and equity accounts
Statement of retained earnings: prepared from net income and dividend
information
Cash flow statement: derived from the other financial statement using either the
direct or indirect method.

Finally, all the revenue and expense accounts are closed.

Step 8 – Closing entries.

Revenues and expenses are accumulated and reported by period, monthly, quarterly, or
yearly. To prevent them not being added to or co-mingled with revenues and expenses of
another period, they need to be closed out- that is, given zero balances at the end of each
period. Their net balances, which represent the income or loss for the period, are
transferred into owners’ equity. Once revenue and expense accounts are closed, the only
accounts that have balances are the asset, liability, and owners’ equity accounts. These
balances are carried forward to the next period.

Step 9 – Prepare post-closing trial balance.

The purpose of this final step is two-fold: to determine that all revenue and expense
accounts have been closed properly and to test the equality of debit and credit balances of
all the balance sheet accounts, that is, assets, liabilities and owners’ equity.


TOPIC SUMMARY
You have just looked at the accounting cycle and the steps in the accounting cycle. As you
continue with the other topics in this unit you will examine the accounting cycle in more
detail. We will now continue and look at the business accounting processes and
procedures.


TOPIC 1.3 BUSINESS ACCOUNTING PROCESS AND PROCEDURES
TOPIC INTRODUCTION
Accounting processes and procedures are usually based on the basic accounting cycle. The
accounting process outlines how financial information flows through a business. It also
identifies which individuals are responsible for the information. In order for the owners of
a business to make sound decisions, they will need financial information that accurately
reflects the "true and fair view" of the financial performance and position of the business.

TOPIC OBJECTIVES

1. examine accounting assumptions principles and conventions; and
2. identify how these assumptions, principles and conventions are used.

ACCOUNTING ASSUMPTIONS, PRINCIPLES AND CONVENTIONS
Accounting is used to communicate financial information. It is based on twelve
fundamental concepts that form the basis for all the General Accepted Accounting
Principles (GAAP). Once these concepts are used as the foundation, readers of financial
statements and other accounting information do not need to make assumptions about
what the number means. The concepts and conventions were adopted to support the
“true and fair view” approach of preparing financial statement for a business.

The table 1.2 indicates the accounting assumptions, principles and conventions.

Assumptions Principles Conventions

Separate Entity Historical Cost Materiality

Going Concern Matching Cost Benefits

Money Measurement Realization of Income Conservatism

Time Period Full Disclosure Consistency

Dual Aspect

Table 1.2

Let’s look further at these assumptions, principles and conventions.

ACCOUNTING ASSUMPTIONS
Separate Entity – this convention states that the business is an entity separate from its
owner. Therefore, business records should be separated from the records of the owner.
(Knol, 2009)


Going Concern – assumes that the entity will continue to operate indefinitely. It implies
that the business will continue to operate for an indefinite period of time in the foreseeable
future. This concept allows business to spread (amortize) the cost of fixed assets over its
expected useful life. (Knol, 2009)

Money Measurement - assumes that items are not accounted for unless they can be
quantified in monetary terms. (Knol, 2009) Financial statements shows only a limited
picture of the business. They do not consider the business’s other valuable resources
(workforce, brand recognition, quality of management) because they cannot be quantified
in monetary terms.

Time Period – allows the performance evaluated of a “Going Concern” business to be
broken up into specific period of time such as month, a quarter or a year. (Knol, 2009)

ACCOUNTING PRINCIPLES
Historical Cost – requires that business assets be recorded at the actual price paid to
acquire them. No account is made for the changing value of these assets. (Knol, 2009)
Transactions are recorded at cost and not at its market value.

Matching – to avoid overstatement of income in any one period, the matching principle
requires that revenue and related expenses be recorded in the same accounting period
(moneyinstructor.com). Accountants should prepare accruals at the end for the reporting
period to account for expenses incurred but for which there is no source document.

Realization of Income – revenue are recognized when they are earned. This occurs when
the seller received cash or claim to cash in exchange for goods and services.
(moneyinstructor.com)

Full disclosure – requires financial statements provide sufficient information to assist users
of the information make knowledgeable and informed decisions about the business. (Knol,
2009)

Dual Aspect – is based on the accounting equation. All transactions must meet the
equation in balance. Financial transactions are allocated both a debit and credit entry in
the accounts. (Knol, 2009)

ACCOUNTING CONVENTIONS
Materiality – events are only recorded if it’s significant enough to justify the usefulness of
the information. (Moneyinstructor.com)

Cost Benefits – since the value of assets change over time it would be impossible to
accurately record the market value for the assets. There it is recorded at the price paid to
acquire it. (Moneyinstructor.com)


Conservatism – requires that profit should not be taken into account unless it’s actually
realized in cash while all possible losses must be fully provided for. This ensures that you
financial statement does not overstate the business financial position.
(Moneyinstructor.com)

Consistency – The same method of reporting should be used to ensure that any differences
in the financial position between reporting periods is as a result of change in operating and
not changes in the way items are accounted for. (Moneyinstructor.com)

The accounting process consists of the following groups of functions listed in illustration 1.2

Illustration 1.2

Accountants observe many events (or activities) and identify and measure in financial terms
(dollars) those events considered evidence of economic activity. (Often, these three
functions are collectively referred to as analyse.) The purchase and sale of goods and
services are economic events.

Next, the economic events are recorded, classified into meaningful groups, and
summarized.

Accountants report on economic events (or business activity) by preparing financial
statements and special reports. Often accountants interpret these statements and reports
for various groups such as management, investors, and creditors. Interpretation may


involve determining how the business is performing compared to prior years and other
similar businesses.

TOPIC SUMMARY
In this unit we dealt with accounting assumptions, principles and conventions. These form
the basis of the General Accepted Accounting Principles (GAAP) and support the true and
fair view approach of preparing financial statements.


TOPIC 1.4 THE ACCOUNTING EQUATION AND BALANCE SHEET
INTRODUCTION
The whole of accounting is based a very simple idea called the accounting equation. It
sounds complicated, but in fact it is easy to understand. This equation is expressed in the
Balance Sheet and states the following:

Assets = Liability + Owners Equity

OBJECTIVES
Upon completion of this topic, you should be able to:

1. State the basic accounting equation
2. Describe the relationship of the accounting equation to the balance sheet.
3. understand what is meant by assets, liabilities and owners’ equity

The balance sheet, sometimes called the statement of financial position, lists the business’s
assets, liabilities, and owners’ equity (including dollar amounts) as of a specific moment in
time. That specific moment is the close of business on the date of the balance sheet. A
balance sheet is like a photograph; it captures the financial position of a business at a
particular point in time. As you study about the assets, liabilities, and owners’ equity
contained in a balance sheet, you will understand why this financial statement provides
information about the solvency of the business.

Catina’s Beauty Saloon
Balance Sheet
As at 31st December 2010

Assets (in $) Liabilities & Equity (in $)
Cash 10,000 Accounts Payable (Creditors) 1,600
Accounts Receivables (Debtors) 1,700 Notes Payable 2,000
Motor Vehicle 20,000 Total Liabilities 3,600
Equipment 3,500 Equity
Cash at Bank 15,000 Capital 25,600
Retained Income 21,000
50,200 50,200

Illustration 1.3

Let’s examine the items in the Balance Sheet in illustration 1.3. It shows that the total assets
should equal the total liabilities and owners’ equity.

Assets as stated in Topic 1.1 are things of value owned by the business. They are also called
the resources of the business. Assets have value because a business can use or exchange
them to produce the services or products of the business. Assets are the economic
resources of the entity, and include such items as cash, accounts receivable (amounts owed
to a firm by its customers), inventories, land, buildings, equipment, and even intangible


assets like patents and other legal rights and claims. Assets are presumed to entail probable
future economic benefits to the owner.

In illustration 1.3 the assets of Catina’s Beauty Salon amount to USD 50,200. Her assets
consist of cash, accounts receivable (amounts due from customers for services previously
rendered), Motor Vehicle, equipment and cash at bank.

Liabilities are the debts owed by a business. Typically, a business must pay its debts by
certain dates. A business incurs many of its liabilities by purchasing items on credit.
Liabilities are amounts owed to others relating to loans, extensions of credit, and other
obligations arising in the course of business.

Catina’s Beauty Saloon liabilities consist of accounts payable (amounts owed to suppliers for
previous purchases) and notes payable (written promises to pay a specific sum of money)
totalling USD 3,600.

Catina’s Beauty Saloon is a sole proprietorship. The owners’ interest in the business is
referred to as Owners equity. Owners' equity is the owner's "interest" in the business. It is
sometimes called net assets, because it is equivalent to assets minus liabilities for a
particular business.

Catina’s equity consists of (1) USD 25,600 capital investment and (2) retained income of
USD21, 000. Capital stock shows the amount of the owners’ investment in the business.

We will discuss these items later in the course. At this point, simply note that the balance
sheet heading includes the name of the organization and the title and date of the statement
(notice that the dollar amount of the total assets is equal to the claims on or interest in
those assets). The balance sheet shows these claims under the heading “Liabilities and
Equity”.

THE ACCOUNTING EQUATION
The fundamental accounting equation is the backbone of the accounting and reporting
system. It is central to understanding a key financial statement known as the balance sheet
(sometimes called the statement of financial position). The accounting equation states:

Assets = Liabilities + Owners' Equity

Activity 1 – C
Using the accounting equation can you calculate the missing figures below
1 $25,200 $10,100
2 $17,350 $21,750
3 $71,350 $29,100


From activity 1 – C above, you should have determined that the accounting equation can
be expressed in different forms. Let’s have a look. The accounting equation can be
expressed as:

Liabilities = Assets – Owner’s Equity

So if we use question 1 in the activity above then your liabilities figure should be $15, 100

$25, 200 (Assets) – $10,100 (Owner’s Equity)

The accounting equation could also be expressed as:

Assets = Liabilities + Owner’s Equity

In question 2 above, your Asset figure should be $39,100

17,350 (Liabilities) + 21, 750 (Owner’s Equity)

Another method of expressing the accounting equation is:

Owner’s Equity = Assets – Liabilities

From the question 3 (in the activity above) you should have calculated $42, 250

71, 350 (Assets) - 29, 100 (Liabilities)

HOW TRANSACTIONS IMPACT THE ACCOUNTING EQUATION
Each passing transaction or event brings about a change in the overall financial condition.
Business activity will impact various asset, liability, and/or equity accounts; but, they will
not disturb the equality of the accounting equation. So, how does this happen? To reveal
the answer to this question, let's look at four specific transactions for Catina’s Beauty
Saloon. You will see how each transaction impacts the individual asset, liability, and equity
accounts, without upsetting the basic equality of the overall balance sheet.

Business transactions are measurable events that affect the financial condition of a
business.


1. Purchase an Asset by Cash

On 12 January 2011, Catina purchased addition equipment valued $2,000 by cash.

Balance Sheet

Retained Income 21,000
50,200 50,200

Illustration 1.4
In illustration 1.4, you can see that the cash account has reduced by $2000 and the
equipment increased by the same amount. However, the balance sheet still remained
balanced.

2. Purchase stock on Credit

On 17th January 2011, she purchased stock for use in the Saloon on credit from Hair
Suppliers Ltd $5,000.

Balance Sheet

Stock 5,000 Retained Income 21,000
55,200 55,200

Illustration 1.5

Observe the difference in Accounts Payable and inclusion of Stock in illustration 1.5 above
but the balance sheet still remain equal.


3. Payment of a Liability

On the 21st January, 2011 Catina made a payment to her suppliers $1,000 by cheque.

Balance Sheet

54,200 54,200

Illustration 1.6

Changes have been made to the Accounts Payable and the Cash at Bank account to reflect
the transaction, however, the Balance still remains balanced.

4. Collection of an Asset

On the 28th January 2011, J Brown one of Catina’s debtors paid her amount owning $500 by
cash.
Balance Sheet

54,200 54,200

Illustration 1.7

The cash at Bank is affected whenever payment is made by cheque. Since the cheque is a
means of depositing or withdrawing from your bank account. Again adjustments are made
to the accounts affected by the transaction and the Balance Sheet.


Self-Reflection Question

Take this opportunity to review the topics in this unit and ask yourself the
following questions.

1. Do I understand how a transaction affects items on the Balance Sheet?

2. Do I understand the various methods in which the accounting equation can be
expressed?

3. Am I able to make adjustments to my Balance Sheet after business
transactions?


UNIT REFERENCES
1. Wood, F., & Robinson, S. (2007). Principles of Accounts for the Caribbean (5th ed.).
England, Pearson Education Limited.
2. Holdip, G., & Lamorell, C. (2010). Principles of Accounts for CSEC Examinations.
Macmillan Publishers Ltd.
3. http://www.differencebetween.net/business/difference-between-accounting-and-
bookkeeping-2/#ixzz1GfqZ4iSs
4. http://knol.google.com/k/nowmaster-accounting/what-are-the-accounting-
concepts-and/y2cary3n6mng/11#
5. http://www.moneyinstructor.com/lesson/accountingconcepts.asp
6. http://www.scribd.com/doc/9295030/Accounting-Concepts-and-Conventions
7. http://docs.globaltext.terry.uga.edu:8095/anonymous/webdav/Accounting%20Prin
ciples/Accounting%20Principles%20Vol.%201.pdf
8. http://www.principlesofaccounting.com/chapter%201.htm
9. http://www.ehow.com/about_4679149_purpose-accounting_.html


UNIT SUMMARY

Unit Assignment

Balance Sheet
As at 28th January, 2011

Assets $ Liabilities and Equity $
Account Receivables (Debtors) 1,200 Notes Payable 2,000
54,200 54,200

Catina’s Beauty Saloon had the following business transactions in the month of
February 2011. Make the necessary adjustment to the accounts and update her
Balance Sheet as at 28th February 2011.

Feb 1 Catina deposited $5,000 cash into her Cash at bank account

Feb 3 she purchased stock $2,500 by cheque

Feb 7 paid a cheque of $500 to a creditor'

Feb 12 A debtor paid Catina $300 by cheque

Feb 15 Received a Loan from L. Stennett $10,000 by cheque

Feb 20 bought equipment $8,000 by cheque

SUMMARY
If you understand how accounting information is prepared, you will be in an even stronger
position when faced with a management decision based on accounting information. The
accounting process provides financial data for a broad range of individuals whose objectives
in studying the data vary widely. Reliable information is necessary before you can make a
sound decision involving the allocation of scarce resources. Accounting information is
valuable because it is used to evaluate the financial consequences of various alternatives.

Accountants can reduce uncertainty by using professional judgment to quantify the future
financial impact of taking action or delaying action. Although accounting information plays
a significant role in reducing uncertainty within your business, it also provides financial data


for persons outside the business. This information tells how management has discharged its
responsibility for protecting and managing the business's resources.

Accounting is often confused with bookkeeping (discussed earlier). Bookkeeping is a
mechanical process that records the routine economic activities of a business. Accounting
includes bookkeeping but goes well beyond it in scope. Accountants analyse and interpret
financial information, prepare financial statements, conduct audits, design accounting
systems, prepare special business and financial studies, prepare forecasts and budgets, and
provide tax services.


UNIT 1 SUGGESTED ANSWERS
Activity 1 – B

Complete the illustration below to demonstrate your understanding of the types of accounting and the
users of the accounting information using examples.

Activity 1 – C

Using the accounting equation can you calculate the missing figures below

Assets Liabilities Owners Equity

$ $ $

1. 25, 200 15,100 10,100

2. 39,100 17,350 21,750

3. 71, 350 29,100 42,250


UNIT 1 – ASSIGNMENT ANSWERS

Cash 8,500 – 5,000 = 3500

Bank 14,000 + 5,000 - 2,500 – 5,00 + 300 + 10,000 – 8,000 = 18, 300

Stock 5,000 + 2, 500 = 7,500

Accounts Payable 5,600 – 500 = 5,100

Accounts Receivable 1,200 – 300 = 900

Notes Payable 2, 000 + 10, 000 = 12,000

Equipment 5,500 + 8,000 = 13,500


Balance Sheet

As at 28th February 2011

Assets $ Liabilities and Equity $
Account Receivables (Debtors) 900 Notes Payable 12,000
Stock _7,500 Retained Income 21,000
63,700 63,700

NEXT STEP
You have come to the end of Unit One. In Unit Two we will look at the Double Entry
System of Accounting.


UNIT TWO – DOUBLE ENTRY SYSTEM OF ACOUNTING

INTRODUCTION
In Unit One, we illustrated the accounting cycle, we also examined the accounting equation
and how each transaction affects items in the Balance Sheet. In Unit Two we will expand
on the steps in the accounting cycle. We will begin by journalizing the information
gathered from our source documents then continue with an exploration of the double
entry system of bookkeeping.

There are two basic kinds of bookkeeping: single entry bookkeeping and double entry
bookkeeping. In the case of single entry bookkeeping each transaction is carried to the
debit column or the credit column. In the case of double entry bookkeeping we can find
two entries for each transactions carried to the Ledger. One entry is carried to the credit
side and the other to the debit side. This is done in the way that the two entries can be
checked. Double entry bookkeeping is the fundamental concept underlying accountancy.
All accounting transactions should be recorded using the double entry system.

After recording your business transactions in your ledger accounts, the different accounts
will be balanced and the balances used to generate your trial balance for the period.

OBJECTIVES

1. Demonstrate the use of double-entry and accounting systems.
2. Record transactions and events.
3. Apply double entry bookkeeping to a list of transactions.
4. Use the account as the basic classifying and storage unit for accounting information.
5. Express the effects of business transactions in terms of debits and credits to different
types of accounts.
6. Record the effects of business transactions in a journal.
7. Post journal entries to the accounts in the ledger.
8. Prepare a trial balance to test the equality of debits and credits in the journalizing and
posting process.

UNIT READINGS



TOPIC 2.1 BOOKS OF ORIGINAL ENTRY
INTRODUCTION
As we take a more in depth look at the accounting cycle we will examine various source
documents and how the information in these documents are transferred to the books of
original entry. You will also have looked at the different books of original entry.

OBJECTIVES

1. Identify different forms of source documents.
2. Transfer information from the source document to the books of original entry.
3. Examine the various books of original entry.
4. State the use of the books of original entry.

SOURCE DOCUMENTS
Before we look any further at the books of original entry, let us look at the source
documents that provide the information to be recorded in the books of original entry.

A source document describes all the basic facts of the transaction, such as the amount of
the transaction; to whom the transaction was made; the purpose of the transaction and the
date of the transaction. Some source documents include:

Source Document 1 - Invoices

Let us look at the invoice in illustration 2.1 below. An invoice is a document that contains a
detailed description of the item sold, unit price and the terms and conditions of the sale.

The invoice is numbered and gives a detailed description of the item(s) sold or purchased:
the quantity, the list price per unit, trade discounts allowed and the net cost of the item.
Also, included on the invoice will be the terms of payment and the name and address of the
customer and the name and address of the issuing firm. A number of copies are usually
made and routed to different departments within the issuing firm.

There are two types of invoices:

1. Purchases Invoices - reflects credit purchases of stock (Holdip and Lamorell 2010)
2. Sales Invoices - reflects credit sales of stock (Holdip and Lamorell 2010)


Your Purchase Order 12/B/124
AJ Wholesale
Factory Road Name and address of
St. John's supplier (seller)

Antigua

Date of transaction
7-Sep-06
To: MJ Retailers
Buyer Hilda Davis Drive
St. John's
Invoice number
INVOICE NO. 1654
Quantity Per Unit Total
$ $
7 cases fruit juices 35.00 245.00
4 cases ideal milk 24.00 96.00

341.00 Sub-Total
less 20% Trade Discount 68.20
Total
272.80
Discount given to encourage person to buy in bulk

Illustration 2.1

Discounts

A discount is a reduction in the price of an item. In order to encourage prompt payment by
customers, cash discounts may be offered. Customers are allowed a specified percentage
off the amount payable if paid within a stated time period. Discount Received is an
allowance you receive for making prompt payment for the goods and services you receive
from your suppliers. Discount Allowed is the allowance you give to your customers for
making prompt payment for the goods and services they received from your business.

Trade discounts are reductions in the invoice price of the goods and are given to encourage
trade and increase the volume of good purchased. Trade discounts are not recorded in the
ledger accounts although they may be noted in the relevant day book. Cash discounts are
recorded in the accounting records

Source Document 2 - Debit Notes

A Debit Note is sent by the business to the supplier giving details of a claim for an allowance
in respect to goods returned. (Wood and Robinson 2007) (Illustrated below).


MJ Retailers
Hilda Davis Drive
St. John's
Antigua

26-Sep-06
To: A.M Bryden
Fort Road
St. John's

DEBIT NOTE NO. 237
$ $
1 case ideal milk 24.00 24.00
94.00

Illustration 2.2

Source Document 3 - Credit Notes

The supplier will issue a credit note to the customer (debtor) showing the amount of the
agreed reduction (Wood and Robinson 2007) (Illustration 2.3)

MJ Retailers
Hilda Davis Drive
St. John's
Antigua

23-Sep-06
To: Malika Diantha
Green Bay
St. John's

CREDIT NOTE NO. 1235
$ $
1 case tomato paste 32.00 32.00
80.00
Less 10 % trade
discount 8.00
72.00

Illustration 2.3


Source Document 4 - Cash Receipts

The cash receipt is a simple document of a transaction that is often issued at the time of the
completion of a sale. Many businesses issue cash receipt as a matter of course. While the
printed document is normally a simple record of the transaction, some examples of the cash
receipt can be very detailed. (www.wisegeek.com) (Illustrated below 2.4)

Number 00125
Date 21 Sept 2006

Cash Sales Receipt
Name ___________Makayla Adora______________________
Address _____________12 Old Road_______________________
_______________Urlings__________________________

On
Sold By Cash C.O.D Charge Account Paid Out

Quantity Description Price Amount
2 Cases milk 24.00 48.00

Subtotal 48.00
Received by Tax
__________________________ Total 48.00

Illustration 2.4

Source Document 5 - Cheque Stubs

A cheque instrument (usually a piece of paper) that orders a payment of money. The
person writing the cheque, the drawer, usually has a chequing account where their money
was previously deposited. The drawer writes the various details including the money
amount, date, and a payee on the cheque, and signs it, ordering their bank, known as the
drawee, to pay this person or company the amount of money stated. (Source: Wikipedia)


1. drawee, the financial institution where the cheque can be presented for payment
2. payee
3. date of issue
4. amount of currency
5. drawer, the person or entity making the cheque
6. signature of drawer
7. Machine readable routing information

Other Source Documents

Below are some additional examples of source documents:

1. Petty Cash Vouchers – records of claims of small expenditures (Holdip and Lamorell
2010).
2. Time Cards – record of hours worked by employees (Holdip and Lamorell 2010).
3. Stock Cards – records of materials etc. Purchased (Holdip and Lamorell 2010).
4. Bank Statements – records of transactions with the bank (Holdip and Lamorell
2010).
5. Cash Bills/Invoices – given to customers and received from suppliers as proof of
purchase. (Holdip and Lamorell 2010).

BOOKS OF ORIGINAL ENTRY
Now that you know what source documents are you can now move on to the books of
original entry.

The books of original entry consist of five Journals or Day Books and the Cash Book.

1. Sales Journal (Day Book) is used to record the credit sales of goods normally traded by
the business. The information from the sales invoices is transferred to the sales day
book. It is a list of all of your Accounts Receivables (Debtors).

2. Purchase Journal (Day Book) is used to record the credit purchases of goods normally
traded by the business. The information from the purchases invoice is transferred to
the purchases journal or day book. It is a list of the Accounts Payable (creditors).


3. Purchases Return Journal (Day Book) records all of the purchased returned to your
suppliers. These may be returned for various reasons (wrong size, colour, damaged
etc.). To indicated that goods were returned to the suppliers a debit note is used the
information from the debit note is then transferred to the Purchased Return Day Book.

4. Sales Return Day Book records all your sales that have been returned to you by your
customers. Your customer is issued a credit note to indicate what was returned and
the allowance given for the return. This information is then transferred to the sales
return day book.

5. The General Journal has several uses these include entries for the following
opening entry - this is a list of assets, liabilities, and capital used to open a new set
of accounting books
the purchase and sale of fixed assets for cash and on credit
writing-off bad debts
the correction of errors
the creation of provision for bad and doubtful debits
the creation of provision for depreciation
adjusting entries for accruals and prepayments
closing entries
unusual one-of-a-kind transactions

6. Cash Book records all the cash transactions of your business. This includes transactions
paid for by cash or by cheque. It also records an allowance given or received as a cash
discount.

The journals generally contain the following columns:

1. Date - day, month, year
2. Details/Particulars - account titles
3. Folio - this is a reference code showing the ledger page to which the entry will be
posted.
4. Amount - the net monetary amount shown invoice or other source on the
document.


Books of Original Entry Source Documents Types of Transactions

Sales Journal Sales Invoice Credit sales of stock

Purchases Journal Purchases Invoice Credit purchases of stock

Purchases Return Debit Note Stock returned to suppliers

Sales Return Credit Note Stock returned by customers

General Journal Invoices, bills, vouchers All other types of transactions

*Cash Book Receipts, bills, cheque All cash and bank transactions

*Petty Cash Book Petty Cash Vouchers Small payments and receipts

*These books/journals all have the same format or layout with the exception of the cash
and petty cash book.
Table 2.1
(Holdip and Lamorell 2010)

Table 2.1 above shows the link between the books of original entry and the source
documents. You can now have a further look at the links between the source documents
and the books of original entry.

PURCHASE ORDER AND PURCHASE INVOICE
A purchase invoice is a document that is issued from a seller to a buyer. It is sent to the
customer who has purchased a product or service. This can also be called a bill or a billing
statement and it is generally a document that details the services that have been or will be
provided (or the items purchased), quantity, price, and other details. By accepting an
invoice, a buyer is basically making a contractual agreement to make the purchase.

A purchase order is a document that is issued from a buyer to a seller. A buyer who is
interested in making a purchase of products or services sends the document to the seller. A
purchase order will also detail the services or the items to be ordered or purchased,
including the quantity, price and other details. A purchase order also serves as a contractual
agreement. The buyer is agreeing to make the purchase, and the seller, upon accepting the
purchase order, is agreeing to provide the goods or services according to the specifics in the
purchase order.

After placing an order with the selected supplier, the supplier sends the purchasing firm a
copy of the purchase invoice. This is then used to record the transaction in the Purchases
Journal. The purchase invoice is then filed for future reference. The suppliers listed in the
Purchases Journal are called creditors, because the business owes them money.


SALES ORDER AND SALES INVOICE
Sales orders indicate that the seller of the goods or services needs to take action (i.e., to
complete the order). Usually this involves finding the product, packaging it, etc., or setting
up a meeting so that services can be rendered.

Sales Invoices indicate that buyer needs to take action. This typically means that the buyer
needs to compensate the business monetarily for the products or services received.

Sales Journal
Folio
Date Details No. Invoice No. Amount

GENERAL JOURNAL
The General Journal is one of the first books in which a transaction is recorded. In some
cases, all transactions are first recorded in the General Journal. In larger firms, where other
books or original entry are used, the General Journal is restricted to only recording specific
kinds of transactions. The General Journal is used to record transactions which cannot be
recorded in any other book of original entry, or unusual one -time transactions. The process
of entering transaction in the General Journal is called journalising.

The journals generally contain the following columns:

1. Date - day, month, year
2. Details/Particulars - account titles
3. Folio - this is a reference code showing the ledger page to which the entry will be
posted.
4. Debit – the monetary amount to be debited is shown,
5. Credit - the monetary amount to be credited is shown.


General Journal
Date Details Folio No. Debit Credit
2006 $ $
Name of account to be debited
Name of account to be credited
Narrative
A Narrative is a brief description of an entry in the journal.

CASH BOOK
There are often several cash accounts because they serve different purposes. The Cash
in Bank account represents the checking account that processes deposits, checks and
memorandum items. The Cash Short and Over account is used to record any variance
by sales clerks. The Cash on Hand Fund is used to provide change to conduct business
with customers. The Petty Cash Fund is used to pay for small items with cash. Each of
these cash accounts needs to be strictly controlled to prevent mishandling. The cash
book replaces the need to have a separate cash account and cash at bank account since
they both merged to form the cash book.

Cash Book

Date Details Folio Discount Cash Bank Date Details Folio Discount Cash Bank

2006 $ $ $ 2006 $ $ $

WORKED EXAMPLE
Let us now look at the source documents and books of original entry at work by examining
the worked example.

MJ Retailers started business on 1 September 2006 with the following assets and liabilities

Cash $ 150

Bank $ 800

Motor Van $ 2 500

Loan from J Smith $ 1 500

Stock of Goods $ 1 200


He also had the following source documents:

Purchase Invoices

AJ Wholesale
Factory Road
St. John's
Antigua

7-Sep-06
To: MJ Retailers
Hilda Davis Drive
St. John's
INVOICE NO. 1654
$ $

341.00
272.80
7 September - Purchase goods on credit form AJ Wholesale $272.80

A M Byden
Fort Road
St. John's
Antigua

09-Sep-06
To: MJ Retailers
Hilda Davis Drive
St. John's
INVOICE NO. 234
$ $
2 cases tomato paste 32.00 64.00
311.00
248.80

9 September - Purchased goods on credit from A M Byden $248.80


Sales Invoices
Your Sales Order 12/B/123
MJ Retailers
Hilda Davis Drive
St. John's
Antigua

25-Sep-06
To: Malika Diantha
Green Bay
St. John's

INVOICE NO. 5324

$ $
422.85

25 September - Sold goods on credit to Malika Diantha $422.85

Your sales Order 12/B/124
MJ Retailers
Hilda Davis Drive
St. John's
Antigua

27-Sep-06
To: Oren Peters
Pigotts
St. John's
INVOICE NO. 249

$ $

249.00

27 September - Sold goods on credit to Oren Peters $249.00


Debit Notes

J Retailers
Hilda Davis Drive
St. John's
Antigua
16-Sep-06

To: A.M Byden
Fort Road
St. John's

DEBIT NOTE NO. 236


$ $
94.00

7 September - MJ Retailers returned goods to AM Byden $94

J Retailers
Hilda Davis Drive
St. John's
Antigua
16-Sep-06

To: AJ Wholesale
Long Street
St. John's

DEBIT NOTE NO. 237

$ $
59.00

25 September - MJ Retailers returned goods to AJ Wholesale $59


Credit Notes
MJ Retailers
Hilda Davis Drive
St. John's
Antigua
23-Sep-06
To: Malika Diantha
Green Bay
St. John's



$ $
1 case tomato paste 32.00 32.00
80.00
Less 10 % trade
discount 8.00
72.00

23 September - A customer Malika Diantha returned goods to MJ Retailers $72.00

MJ Retailers
Hilda Davis Drive
St. John's
Antigua
29-Sep-06
To: Oren Peters
Pigotts
St. John's

$ $
153.00
Less 10 % trade discount 15.30
137.70

29 September - Oren Peters returned goods $137.70 to MJ Retailers


Cash Receipt

Number 00125
Date 21 Sept 2006

Cash Sales Receipt

Name ___________Makayla Adora______________________
Address _____________12 Old Road_______________________
_______________Urlings__________________________

Sold By Cash C.O.D Charge On Account Paid Out

2 Cases milk 24.00 48.00

Subtotal 48.00
Received by Tax
__________________________ Total 48.00

21 September - Cash Sales $48

Number 00105
Date 30 Sept 2006

Cash Sales Receipt
Name ___________Prosper Thomas______________________
Address ___________10 anchorage Road __________________
_____________Point Edge________________________

Sold By Cash C.O.D Charge On Account Paid Out

3 Cases milk 24.00 72.00
1 Cases Tomato Paste 32.00 32.00

Subtotal 104.00
Received by Tax
__________________________ Total 104.00

30 September - Cash Sales $104


Cheques

Dollar Bank
High Street
St. John’s
Antigua Date 25 September 2006

PAY A M Byden $ 100.00

One Hundred

MJ Retailers
Hilda Davis Drive
St. John’s
Antigua MJohn .
O00-0009-00987-0124

25 September - Paid A M Byden $100 by cheque

Dollar Bank
High Street
St. John’s
Antigua Date 27 September 2006

PAY AJ Wholesale $ 75.00

Seventy-Five .

MJ Retailers
Hilda Davis Drive
St. John’s
Antigua MJohn .
O00-0009-00987-0125

27 September - Paid AJ Wholesale $75 by cheque.

Record the above source documents in the Books of Original Entry for MJ Retailers.

General Journal


Let us begin with the General Journal. Remember that one of uses of the General Journal is
to record opening entries of the business. The opening entries for MJ Retailers are
recorded in the Journal below

General Journal
2006 $ $
1Sept Cash CB 150.00
Bank CB 800.00
Motor Van GL 2 500.00
Loan: J Smith PL 1 500.00
Equipment GL 1 200.00
*Capital GL 3 150.00
Assets and Liabilities as at 1 Sept 2006 4 650.00 4 650.00
*The capital figure is calculated by using the accounting equation.

The figures in this general journal will be transferred as the opening balances in the
respective accounts in the ledgers.

Sales Journal

The Sales Journal records the information from the sales invoice. It is a list of our customers
who purchase our goods and services on credit. The total of the sales journal is transferred
to the sales account in the general ledger.

Sales Journal
Folio
2006 $

Sept 25 Malika Diantha SL 5324 422.85

Sept 27 Oren Peters SL 249 249.00

Total Credit Sales for the month GL 671.85


Purchase Journal

The Purchases Journal is used to record all stock or inventory purchased on credit for
resale. It lists our suppliers we purchase goods and services from on credit. The total of the
purchases journal is transferred to the purchases account in the general ledger.

Purchases Journal
Date Details Folio No. Invoice No. Amount
2006 $

Sept 7 AJ Wholesale 1654 272.80

Sept 9 A M Byden 234 248.80

Total Credit Purchases for the month 521.60

Sales Return Journal

Information from your credit notes is recorded in your sales return journal. The total of this
journal is then transferred to the sales return account in the general ledger.

Date Details Folio No. Note No. Amount
2006 $



Total Sales Return GL 209.70


Purchases Return Journal

The debit note information is recorded in the purchases return journal and the total is
transferred to the purchases return account in the general ledger.

Purchase Return Journal
$

Sept 17 A M Byden PL 236 94.00

Sept 25 AJ Wholesale PL 237 59.00

Total Purchases Returns GL 153.00

Cash Book

The Cash Book is special in a number of ways:

1. All cash and bank transactions are recorded in the cash book.
2. Entries are made in the cash book on almost a daily basis and therefore these
entries are similar to journal entries.
3. The cash book acts as a book of original entry or journal and is also part of the
double entry system.
4. The cash book has its own particular format, which is a columnar T-Account format.
5. Cash discounts allowed and received are recorded in the cash book put posted to
accounts in the general ledger.
6. The cash book is used strictly for transactions that involve the immediate transfer of
cash, which makes it easier to track the inflows and outflows of cash.

The Cash Book is written up from information provided by several source documents, which
include

Cash bills and receipts
cheques
cash vouchers
credit and debit card receipts


Bank Statement Cash Book


2006 $ $ $ 2006 $ $ $

01 Sept Balance b/d 150.00 800.00 25 Sept A M Byden 100.00

21 Sept Sales 48.00 27 Sept AJ Wholesale 75.00

30 Sept Sales 104.00

TOPIC SUMMARY
In this topic, you studied source documents and the information contained and also the
books of original entry their content and uses. You learned to identify different source
documents and transfer the information from these source documents to the relevant
books of original entry.


UNIT ASSIGNMENT
Unit 2 Assignment A

A sole trader has the following opening balances at the beginning of November 2008

$
Motor Van 1 500
Bank 2 910
Cash 2 600
Premises 2 000
Fixtures 600
Stock 1 289
Debtors: H. Woods 120
J Benjamin 40
H Ross 180
Creditors: A. Jackson 200
L Luke 60
Loan: R. Richardson 4 000

During the month of September the following transactions occurred.
Nov 1 Receipt for rent paid by Cheque $15
2 Bought good on credit from A. Jackson $20, L Luke $38, C Harris $56, F. Walker $69
3 Paid motor expenses in cash $13
4 Antigua Commercial Bank Deposit slip for $1000
5 Sold good on credit to J Benjamin $56, H. Ross $78, A Lewis $98, J Jacobs $118
6 Good returned to A. Jackson $15, F. Walker $12
7 Paid staff by cheque $150
8 Bought a motor van on credit from Hadeed Motors $500
9 Goods returned to us by A Lewis $14
10 Sales Invoices A Lewis $25, J Benjamin $15
11 Credit notes: J Benjamin $10, J Jacobs $25
15 Debit note C Harris $10
16 Repaid R Richardson $175 by cheque
18 Cash Sales $250
19 Purchase goods by cheque $300 receiving a 5% cash discount
20 Receipt for rent paid by cheque $100
21 Antigua Commercial Bank deposit slip for $500
22 Paid carriage $218 by cash
23 H. Ross paid us in cash $150 receiving a 2% cash discount
24 The proprietor brought equipment $600 from his personal money for the business.
25 Cash Sales $ 300

Prepare the relevant books of original entry from the transactions of MMR Retail Store for
the month ended 30 November 2008.


TOPIC 2.2 RECORDING BUSINESS FINANCIAL TRANSACTIONS
INTRODUCTION
In this topic, we will examine how to identify business transactions and how to record the
transactions in the financial records of your business.

The raw data of accounting are the business transactions. We learned how to record the
transactions in Unit One, based on the increases or decreases in the assets, liabilities, and
owners' equity items of the accounting equation. This procedure illustrated how various
transactions affect the accounting equation. When working through the sample
transactions, you should have noted that listing all transactions as increases or decreases in
the balance sheet would be too cumbersome in practice. Most businesses, even small
ones, enter into many transactions every day. Unit Two will demonstrate how to actually
record business transactions in the accounting process.

We will learn how to post the information from the journal to the ledgers. The ledger will
then be balanced and a Trial Balance extracted.

OBJECTIVES

1. Identify business transactions.
2. Record transactions in a double entry set of books.
3. Define an account.
4. State the steps in the recording business transactions.
5. Identify the effects of business transactions.
6. Identify the information to transfer to the different ledgers.
7. Record merchandising transactions in the ledgers.
8. Record accounts receivable and accounts payable transactions.
9. Record transactions for assets, liabilities and owners’ equity.

BUSINESS TRANSACTIONS
To explain the dual procedure of recording business transactions with debits and credits,
you need to understand how to use the following new tools: the T-account, the journal, and
the ledger. Using these tools, you can follow your business through its various business
transactions. Like accountants, you can use a trial balance to check the equality of your
recorded debits and credits. Understanding this system enables you to better understand
the content of financial statements so you can use the information provided to make
informed business decisions.


THE ACCOUNT AND RULES OF DEBIT AND CREDIT
A business may engage in thousands of transactions during a year. An accountant classifies
and summarizes the data in these transactions to create useful information. Business
transactions are measurable events that affect the financial condition of a business.

Illustration 2.1 – The Steps in Recording and Posting the Effects of a Business Transaction

Look at illustration 2.1 and observe the steps in recording and posting the effects of a
business transaction. Note that source documents provide the evidence that a business
transaction occurred. These source documents include such items as bills received from
suppliers for goods or services received, bills sent to customers for goods sold or services
performed and cash register tapes. The information in the source document serves as the
basis for preparing a journal entry. Then a firm posts (transfers) that information to
accounts in the ledger. You can see from the illustration that after you prepare the journal
entry, you post it to the accounts in the ledger.

However, before you can record a journal entry, you must understand the rules of debit
and credit. To understand these rules, you must first understand the nature of an account.

Most business transactions are repetitive. This makes the task of accountants somewhat
easier because they can classify the transactions into groups having common
characteristics. For example, a business may have thousands of receipts or payments of
cash during a year. Part of every cash transaction must be recorded and summarized in a
single place called an account.

AN ACCOUNT
An account is a part of the accounting system used to classify and summarize the increases,
decreases, and balances of each asset, liability, owners' equity, revenue, and expense
items. Businesses set up accounts for each different business element, such as cash,
accounts receivable, and accounts payable. Every business has a Cash account in its
accounting system because knowledge of the amount of cash on hand is useful information.

Accountants may differ on the account title (or name) they give the same item. For
example, one might name an account Notes Payable and another might call it Loans


Payable. Both account titles refer to the amounts borrowed by the business. The account
title should be logical to help the accountant group similar transactions into the same
account. Once you give an account a title, you must use that same title throughout the
accounting records.

The number of accounts in a business's accounting system depends on the information
needs by those interested in the business. The main requirement is that each account
provides information useful in making decisions. Thus, one account may be set up for all
cash rather than having a separate account for each form of cash (coins on hand, currency
on hand, and deposits in banks). The amount of cash is useful information; the form of cash
often is not.

To illustrate recording the increases and decreases in an account, texts use the T-account,
which looks like a capital letter T. The name of the account, such as Cash, appears across
the top of the T. We record increases on one side of the vertical line of the T and decreases
on the other side. A T-account appears as follows:

Debit (Dr) Cash Credit (Cr)

Dr Cash Cr
Date Details Folio Amount Date Details Folio Amount

o D
o
o Date - day, month, year.
o Details – account titles are written here.
o Folio - this is a reference column showing the journal page to which each
entry is transferred from.
o Amount - the monetary amount is shown.

Accountants use the term debit instead of saying, "Place an entry on the left side of the T-
account". They use the term credit for "Place an entry on the right side of the T-account".
Debit (abbreviated Dr) simply means left side; credit (abbreviated Cr) means right side.
Thus, for all accounts a debit entry is an entry on the left side, while a credit entry is an
entry on the right side.

After recognizing a business event as a business transaction, you must analyse it to
determine if it is an increase or decrease effect on the assets, liabilities owners’ equity


items, revenues, or expenses of the business. Then you must translate these increase or
decrease effects into debits and credits.

The accounting requirement that each transaction be recorded by an entry that has equal
debits and credits is called double-entry procedure, or duality. This double-entry
procedure keeps the accounting equation in balance.

The dual recording process produces two sets of accounts—those with debit balances and
those with credit balances. The totals of these two groups of accounts must be equal.
Then, some assurance exists that the arithmetic part of the transaction recording process
has been properly carried out. Below is an example of how to record business transactions
in T-accounts using debits and credits.

While recording business transactions, remember that the foundation of the accounting
process is the following basic accounting equation:

Assets = Liabilities + Owners’ Equity

Recording transactions into the T-accounts is easier when you focus on the equal sign in the
accounting equation. Assets, which are on the left of the equal sign, increase on the left
side of the T-accounts. Liabilities and owners' equity, to the right of the equal sign, increase
on the right side of the T-accounts. Remember the left side of the T-account is the debit
side and the right side is the credit side. So you should be able to fill in the rest of the rules
of increases and decreases by deduction, such as:

Dr Assets Cr

Increase Decrease

Examples of Asset Accounts – Motor Vehicle Expenses, Equipment, Building, Goodwill,
Copyrights, Cash, Accounts Receivable, Stock of Goods, Cash in Bank.

Dr Liabilities Cr

Decrease Increase

Examples of Liability Accounts – Accounts Payable, Notes Payable or Loans, Mortgage.

Dr Owners’ Equity Cr

Decrease Increase

Dr Revenue Amounts Cr

Decrease Increase


Examples of Revenue Accounts – Discount Received, Commission Received, Interest
Received and Rent Received.

Dr Expense Accounts Cr

Increase Decrease

Examples of Expense Accounts – Rent Payable, Salaries and Wages, Commission Payable,
Interest Payable, Discount Allowed.

To summarize:

Assets increase by debits (left side) to the T-account and decrease by credits (right
side) to the T-account.
Liabilities and owners' equity decrease by debits (left side) to the T-account and
increase by credits (right side) to the T-account.
Owners’ equity decrease by debits and increase by credits
Record increases in revenues on the right (credit) side of the T-account and
decreases on the left (debit) side. The reasoning behind this rule is that revenues
increase retained earnings, and increases in retained earnings are recorded on the
right side.
Record increases in expenses on the left (debit) side of the T-account and decreases
on the right (credit) side. The reasoning behind this rule is that expenses decrease
retained earnings, and decreases in retained earnings are recorded on the left side.
Applying these two rules keeps the accounting equation in balance. Now we apply
the debit and credit rules for assets, liabilities, and owners' equity to business
transactions.

REMEMBER EVERY BUSINESS TRANSACTION SHOULD HAVE A DEBIT AND CREDIT ENTRY
IN THE ACCOUNTS.

Let’s record a list of transactions for ORE Retail for the month of February 2011 in their
various accounts.

Dr Owners’ Equity CR
2011 $ 2011 $
Feb 1 Cash CB 15, 000


1 Feb - Started business with $15, 000 in cash

o Debit Cash Account
o Credit Owners’ Equity Account (Capital Account)

Dr Cash CR
2011 $ 2011 $
Feb 1 Owners’ Equity GL 15, 000

The money invested to start a business is recorded in the Owners’ Equity Account. This will
need an increase in that account and also an increase in the cash account. To increase the
Cash (which is an asset account) you debit that account as illustrated above. To increase
the owners’ equity account you credit that account.

Feb 4 Bought a Motor Vehicle paying by cash $2,000

o Debit Motor Vehicle Account
o Credit Cash Account
Dr Motor Vehicle CR
2011 $ 2011 $

Dr Cash CR
2011 $ 2011 $
Feb 1 Owners’ Equity GL 15, 000 Feb 4 Motor Vehicle GL 2,000

Because you have taken $2,000 out of your cash account to pay for the Motor Vehicle your
cash amount has decreased. This is indicated by a credit entry in your cash account. By
purchasing that motor vehicle you have increase your motor vehicle account. This is done
by a debit entry in the Motor Vehicle accounts. Both the motor vehicle and the cash
accounts are asset accounts.


Feb 8 Deposited $5, 000 of the cash into a bank account

o Debit Cash at Bank Account
Dr Cash at Bank CR
2011 $ 2011 $

Dr Cash CR
2011 $ 2011 $
Y
Feb 8 Cash at Bank CB 5,000
o
u
r
Cash Account is being further reduced by taking some of the cash in that account and
depositing it into the cash at bank account, which is now being increased.

Feb 12 He paid his supplier Bargain Wholesale owed $1200 by cheque.

o Debit Bargain Wholesale Account
o Credit Cash at Bank Account

Dr Cash at Bank CR
2011 $ 2011 $
Feb 8 Cash CB 5, 000 Feb 12 Bargain Wholesale PL 1,200

Dr Bargain Wholesale CR
2011 $ 2011 $

Bargain wholesale is a supplier that you owed money that makes it a liability to you.
Because you are paying them the liability is decreasing, therefore, a debit entry is needed in
bargain wholesale account and a credit entry in the cash at bank account to reflect the
payment being made from your cash at bank account by cheque.


Feb 15 Paid rent $500 by cash

o Debit Rent Account
Dr Rent CR
2011 $ 2011 $
Feb 15 Cash CB 500

Dr Cash CR
2011 $ 2011 $
Feb 15 Rent GL 500

Rent is an expense account, which should be debited to indicate that the expense has been
paid. Your cash account is credited to indicate that funds were taken from the cash
account to pay the rent.

Feb 20 Received $150 interest on you cash at bank account

o Debit Cash at Bank Account
o Credit Interest Received Account

Dr Cash at Bank CR
2011 $ 2011 $
Feb 8 Cash CB 5, 000 Feb 12 Bargain Wholesale PL 1,200
Feb 20 Interest Received GL 150

Dr Interest Received CR
2011 $ 2011 $
Feb 12 Cash at Bank CB 1,200 Feb 20 Cash at Bank CB 150

Interest Received is additional revenue received from your bank as an incentive for doing
business with them. This account should be credited to indicate the receipt of the
additional amount. Your cash at bank account is also increased by an additional $150
indicated by the entry in the account.


TYPES OF LEDGERS
The information in the various Journals is transferred to the ledgers. There are three types
of ledgers.

1. Sales Ledger

In the sales ledger are the individual accounts of your Accounts Receivable (Debtors).
The information in these accounts are derived from the Sales Journal and the Sales
Return Journal

2. Purchases Ledger

The individual accounts of your Accounts Payable (Creditors). The information in the
Purchase Journal or Purchases Return Journal is transferred to this Ledger.

3. General Ledger

All other accounts not recorded in the Sales or Purchase Ledger is recorded in the
General Ledger.

MERCHANDISING TRANSACTIONS
Merchandising Transactions requires that you understand how to record the asset of stock.
The asset of stock is recorded in four different accounts. These accounts are purchases,
sales, sales return and purchases accounts. Let us first look at a definition for these terms
and then the use of the accounts.

Purchases, in the accounting sense, are only those items of merchandise inventory that a
firm buys to resell to customers in the normal course of business.

Purchases Return – Merchandise purchased for resale would not always be as what the
buyer expects. In this regard, buyers can return goods purchased due to a lot of reasons, for
example, due to defects, wrong specifications, poor quality, etc. When merchandise bought
is returned, or an allowance is requested, the buyer informs the seller in writing. The
communication is done usually through the buyer’s printed business form called debit note.

Sales, on the other hand, represent the selling price of merchandise previously bought and
then sold. In the income statement, Sales is shown as an income item from which the cost
of goods sold (consisting of merchandise inventory beginning and end and net cost of
purchases), was deducted, the difference being the gross profit.

Sales Return - When the customer returns goods to the seller or requests for a deduction
from the price of the goods delivered to him, the seller accepts the return or grants the
request through a credit note.


The sale of merchandise may be for cash or on account. An invoice supports every sale. The
seller’s sales invoice is the buyer’s purchase invoice. When a sale is for cash, the seller
receives money in return for his merchandise. When the sale is made on credit, the seller
acquires a receivable or right to collect from the buyer.

The uses of the merchandising accounts are:

1. Sales Account – Sales of merchandise are recorded in this account at selling prices. This
is a temporary or nominal account representing income from selling of merchandise.
This account has a normal credit balance.

2. Purchases Account – This is a temporary account to which the cost of goods bought
during the period is debited. This account usually has a debit balance at the end of the
accounting period.

3. Sales Return Account – This account is debited for all the merchandise returned by
customers. The debit entry is at the original selling price of the merchandise. This
account is also being used for all goods delivered to customers but is found to be
defective or not as ordered and still the buyer desiring to retain the goods as is.
The customer in this case is normally permitted to deduct a certain amount
from the selling prices of the goods delivered.

4. Purchases Return Account – Goods bought and returned to supplier, or goods bought
and received as defective, or not as ordered, when not returned to the supplier but is
subjected to a certain reductions from their acquisition prices. These deductions and
returns of purchased goods are credited to this account. Purchase returns and
allowances account is a deduction from the Purchases account.

These accounts were briefly looked at above but let us now have a further look at these
accounts as we take into account the double entries needed to record both credit and cash
transactions in these accounts.

Purchases Transactions
Accounting Entries Used to Record the Purchase and Payment of Goods
1) When goods are purchased with cash, the following entry is necessary:

o Debit Purchases
o Credit Cash

2) When goods are purchased on credit, the following entry is necessary:

o Debit Purchases
o Credit Accounts Payable


3) When goods are purchased on credit, but are paid back early due to a cash discount
incentive, the following entry is necessary.

o Debit Accounts Payable
o Credit Cash
o Credit Purchases Discount (discount received).

Purchases Discounts (Discount Received)

A seller will often offer a cash discount to the buyer for an early payment. Credit terms are
the conditions for the payment agreed upon by the buyer and the seller. Cash discounts are
stated in a fractional form with the percentage of discount in the numerator and the
number of days in the denominator. The credit period, or number of days a buyer can pay
without incurring a finance charge, is stated in NET days or n/days.

Example

Terms 3/15, n/60 means a buyer will receive a 3% cash discount if paid within 15 days of
the invoice date, and the buyer has a maximum of 60 days to pay the entire debt amount.

Purchases Returns Rules For Recording Returns For Goods Purchased On Credit

1) If merchandise is returned or a price adjustment is necessary, the buyer should.

o Debit Accounts Payable
o Credit Purchases Returns account

2) When the returned goods were purchased on credit, and a cash discount for early
payment is available, the discount only applies to the price of the goods that are kept,
(in addition, discounts are not taken on freight costs).

SALES ACCOUNTING
When goods are sold for cash or on credit, the Sales account should be credited. To
encourage early payment of goods purchased on credit, the seller will often offer a cash
discount. These discounts are recorded in the Sales Discounts Account (Discount Allowed).
When goods are returned or an allowance is requested, the adjustment is made to the
Sales Returns account. All sales discounts, returns, and allowances reduce sales revenues.

Sales Accounting - Rules for Recording Sales Transactions

1) When goods are sold and payment is made in cash.

o Debit Cash
o Credit Sales


2) When goods are sold on credit.

o Debit Accounts Receivable
o Credit Sales

Sales Accounting - Recording Sales Discounts

3) When a buyer takes advantage of a cash discount.

o Debit Cash
o Debit Sales Discount (Discount Allowed)
o Credit Accounts Receivable

Example

Invoice for $950 with terms 3/15, n/30 is paid early by the buyer.

o Debit Cash $921.50
o Debit Sales Discount $28.50
o Credit Accounts Receivable $950

SALES ACCOUNTING - RECORDING SALES RETURNS

When a seller grants a return or an allowance,

o Debit Sales Returns
o Credit Accounts Receivable

A buyer of goods can only take a cash discount on the goods that are actually kept (cash
discounts do not apply to freight either).

Example

A seller issues a credit note for $70 of goods that were not ordered by ABC company. If
the return is granted, the following entry is necessary.

Debit Sales Returns $70
Credit Accounts Receivable ABC company $70

SALES ACCOUNTING
Manufacturers and wholesalers often reduce catalogue list prices by allowing trade (or
quantity) discounts. The discounts vary depending on customer and order size. Trade
discounts permit flexible prices without having to print new catalogues. Trade discounts are


not reflected in accounting records, only the agreed upon price between a buyer and seller
is recorded.

TRANSPORTATION COSTS
Whenever goods are sold, the buyer and the seller must agree upon who pays shipping
costs. When goods are shipped FOB shipping point, the buyer agrees to pay for shipping
costs and ownership passes to the buyer when the merchandise is delivered to the shipper.
When goods are shipped FOB destination, the seller agrees to pay for transportation costs
and ownership of goods passes to the buyer when the goods are delivered.

ACTIVITY 2 - A

A Local Book Shop ordered 600 copies of an introductory accounting textbook from a publisher on
March 21, 2011. The books were delivered on September 12, at which time a bill was sent requesting
payment of $60 per book. However, a 5% discount was allowed if the publisher received payment by
October 15. Local Book Shop sent the proper payment, which was received by the Publisher on
October 10. On December 18, Local Book Shop returned 60 books to the publisher for a full cash
refund.

1. Prepare the journal entries (if any) for the publisher on
a. March 21
b. September 12
c. October 10
d. December 18. Include appropriate narratives.

ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
These accounts deal with our debtors (customer who we sell our goods and service to on
credit) and our creditors (suppliers we purchase our goods and services from on credit). The
list of your accounts receivables account are recorded in your Sales Ledger and Accounts
Payable accounts in your Purchases Ledger

Let us now continue with our worked example from Topic 2.1 above. You now need to
transfer the information in the various journals to the different ledgers and accounts.

Begin with the Sales and Sales Return Journals. The information included in these two
journals is transferred to the respective accounts in the sales ledger with the totals
transferred to the general ledger.


Sales Journal
Folio
2006 $



Total Credit Sales for the month GL 671.85

2006 $



Total Sales Return GL 209.70

Sales Ledger
Oren Peters
2006 $ 2006 $
Sept 27 Sales SJ 249.99 Sept 29 Sales Returns SRJ 137.70

Malika Diantha
2006 $ 2006 $
Sept 25 Sales SJ 422.85 Sept 23 Sales Return SRJ 72.00


Purchases Journal
Date Details Folio No. Invoice No. Amount
2006 $

Sept 7 AJ Wholesale 1654 272.80

Sept 9 A M Byden 234 248.80

Total Credit Purchases for the month 521.60

Purchase Return Journal
$

Sept 17 A M Byden PL 236 94.00

Sept 25 AJ Wholesale PL 237 59.00

Total Purchases Returns GL 153.00

Purchases Ledger
A.M. Bryden
2006 $ 2006 $
Sept 17 Purchases Return PRJ 59.00 Sept 9 Purchases PJ 248.80
Sept 25 Bank CB 100.00

AJ Wholesale
2006 $ 2006 $
Sept 25 Purchases Return PRJ 94.00 Sept 7 Purchases PJ 272.80
Sept 27 Bank CB 75.00

J Smith
2006 $ 2006 $
Sept 1 Balance b/d 1 500.00


General Journal
2006 $ $
1 Sept Cash CB 150.00
Bank CB 800.00
Motor Van GL 2 500.00
Loan: J Smith PL 1 500.00
Equipment GL 1 200.00
*Capital GL 3 150.00
Assets and Liabilities as at 1 Sept 2006 4 650.00 4 650.00

General Ledger
Motor Van
2006 $ 2006 $

Capital
2006 $ 2006 $

Equipment
2006 $ 2006 $

Sales Account
2006 $ 2006 $
Sept 21 Cash CB 48.00
Sept 30 Cash CB 104.00
Sept 30 Total Credit Sales SJ 671.85

Purchases Account
2006 $ 2006 $
Total Credit
Sept 30 Purchases PJ 521.60


Sales Return Account
2006 $ 2006 $
Sept 30 Total Returns SRJ 209.70

Purchases Return Account
2006 $ 2006 $
Sept 30 Total Returns PRJ 153.00

Cash Book

2006 $ $ $ 2006 $ $ $

Sept 1 Balance b/d 150.00 800.00 Sept 25 AM Byden PL 100.00

Sept 21 Sales SL 48.00 Sept 27 AJ Wholesale PL 75.00

Sept 30 Sales SL 104.00


UNIT ASSIGNMENT
Unit 2 Assignment B

Using your answers from Unit 2 Assignment A, prepare the double entry accounts for MMR
Retail Store for the month of November 2008.

TOPIC SUMMARY
You would have observed from the examples given in this unit that the accounts on the
balance sheet are affected by business transactions. In this unit we looked at the entries
required to record different business transaction in a business. You would have learnt that
every transaction affects two accounts one account is debited and the other credited. You
would have also looked at the necessary entries needed to increase and decrease each type
of account.

We have completed the double entry recording of different types of accounts and
transactions. We can now continue by balance off these accounts to determine the balance
on the accounts to be transferred to the trial balance.


TOPIC 2.3 BALANCING OFF ACCOUNTS
INTRODUCTION
We will now continue from where we left off in topic 2.2. In order for us to generate a trial
balance we first need to balance off the ledger accounts. Balancing the accounts simply
means that both the debit and credit side of each account should be equal.

OBJECTIVES

1. State what balancing off means.
2. list the steps of balancing off an account.
3. identify what figures are transferred to the income statement and the balance sheet.

BALANCING THE BOOKS
At the end of the financial accounting period a business must balance its books – the first
step to summarizing and analyzing the financial position and income of the business. You
have identified two sides of a ledger – a debit and a credit. All of your debit entries must
equal your credit entries. You must balance off an account by taking a figure to the
financial statements. All ledger accounts must be balances at the end of a period. Revenue
and expense accounts do not have a brought down balance, since they are closed off and
the figure transferred to the income statement. Other types of accounts use a balance
brought down in order to determine the opening balance of the account in the subsequent
trading period.

Steps to balancing off the accounts

1. Calculate the total of both side of the account (one side in the case of revenue and
expense accounts.
2. The larger of the two totals are place in the total boxes on both side of the account
(debit and credit totals). If the debit total is greater than the credit total then the
account has a debit balance and vice versa for the credit balance.
3. You balance your account by introducing your balancing figure (which the difference
between the largest and smaller figure) on the side the smallest amount. This figure
should be your balance carried down at the end of the period and would be brought
down at the start of the next period. The balances carried down figures are those that
affect the balance sheet.
4. You bring down the balancing figure by going to the opposite side of the account and
detailing the balance brought down, which is the same figure as the balance carried
down figure. The balancing figure appears before the total boxes while the brought
down figure appear under the total boxes on the opposite side to that of the balancing
figure.


5. For revenue and expense accounts the difference between both sides of the account is
the figure to be transferred to the income statement.

Balance sheet accounts have balancing figures, but revenue and expenses account do not.
This is because the figures for revenue, expenses and drawing, when they are aggregated
and offset in the income statement, to adjust the capital accounts. As such, the balances of
those accounts appear in the capital account in the following period and do not just
disappear in the next accounting period.

Now let’s balance off the accounts in unit 2.2

Sales Ledger
Oren Peters

2006 $ 2006 $
Sept 25 Sales SJ 249.00 29-Sep Sales Returns SRJ 137.70
30-Sep Balance c/d 111.30
249.00 249.00

1-Oct Balance b/d 111.30

Malika Diantha

2006 $ 2006 $
Sept 30 Sales SJ 422.85 23-Sep Sales Return SRL 72.00
422.85 422.85


Purchases Ledger
A.M. Bryden

2006 $ 2006 $

25-Sep Bank CB 100.00 9-Sep Purchases PJ 248.80
26-Sep Purchases Return PRJ 59.00
148.80 248.80



AJ Wholesale

2006 $ 2006 $
17-Sep Purchases Return PRJ 94.00 7-Sep Purchases PJ 272.80

27-Sep Bank CB 75.00
272.80 272.80


J Smith

2006 $ 2006 $
30-Sep Balance c/d 1 500.00 1-Sep Balance b/d 1 500.00

1-Oct Balance b/d 1 500.00

General Ledger
Sales Account

2006 $ 2006 $
21-Sep Cash CB 48.00
30-Sep cash CB 104.00
30-Sep Income Statement 823.85 30-Sep Total Credit Sales SJ 671.85
823.85 823.85


Purchases Account

2006 $ 2006 $
Total Credit
30-Sep PJ 521.60 30-Sep Income Statement 521.60
Purchases

Sales Return Account

2006 $ 2006 $
30-Sep Total Returns SRJ 209.70 30-Sep Income Statement 209.70

1-Oct Balance 209.70


Purchases Return Account

2006 $ 2006 $
30-Sep Income Statement 153.00 Sept 30 Total Returns PRJ 153.00

1-Oct Balance 153.00

Motor Van
2006 $ 2006 $
2
1-Sep Balance b/d 2 500.00 30-Sep Balance c/d 500.00


Equipment
2006 $ 2006 $
1
1-Sep Balance b/d 1 200.00 30-Sep Balance c/d 200.00


Capital
2006 $ 2006 $
3
30-Sep Balance c/d 3 150.00 1-Sep Balance b/d 150.00
3

Cash Book
2006 $ $ $ 2006 $ $ $
1-Sep Balance b/d 150.00 800.00 25-Sep AM Byden PL 100.00
21-Sep Sales Gl 48.00 27-Sep AJ Wholesale PL 75.00
30-Sep Sales GL 104.00 30-Sep Balance c/d 302.00 625.00

302.00 800.00 302.00 800.00

1-Oct Balance b/d 302.00 625.00


Take note that at the end of the month those accounts with balances to be transferred to
the Income Statement use the word income statement instead of balance c/d.

UNIT ASSIGNMENT
Unit 2 Assignment C

Let us continue the unit 2 assignment from topic 2.1 and 2.2. You have recorded the
transactions in the books and original entry and post them to the various ledgers. You
now need to balance off those ledger accounts.

TOPIC SUMMARY
You are doing well. You have balance off your accounts in the various ledgers. With this
information you can now prepare your trial balance. You will also be able to determine
which final account the balances will be transferred.


TOPIC 2.4 TRIAL BALANCE
INTRODUCTION
Now that we have balanced off our accounts we are now ready to prepare our trial balance.
This will be prepared from the balances on the ledger accounts.

OBJECTIVES

1. Define trial balance.
2. State the uses of the trial balance.

DEFINITION OF TRIAL BALANCE
A Trial Balance is an essential stage in ensuring the accuracy of the book-keeping entries
prior to the preparation of the financial statements. The trial balance lists the name of
each account together with the balance shown in either the debit or credit columns. (Wood
and Robinson, 2007) It is a list of the account balances in your records.

You can extract your trial balance from the balances on your ledger accounts. Before you
prepare your trial balance let us look at the uses of the trial balance.

USE OF THE TRIAL BALANCE
According to Wood and Robinson (2007) Trial Balances may be used:

To check that the books ‘balance’, i.e. every debit entry has been accompanied by a
credit entry.
To ascertain the net amount of the error(s), should an error(s) have been made.
As a basis from which the financial statement are prepared.

The trial balance is used to check the arithmetically balance of our accounts. The trial
balance has two monetary columns a debit and credit column. You would have seen in
your ledger account that some balance b/d are on the debit side of the account and others
are on the credit side. When you are transferring the balances from the ledger accounts to
the trial balance the balances remain on the same side as the ledger accounts.

Below is the Trial Balance from the examples in this unit. Take note that it should have the
following:

1. Heading that states the name of the business, the words Trial Balance as at (the date
the trial balance is being prepared).
2. A details column for the name of the accounts
3. Folio column indicating the reference information
4. A debit and credit monetary column


MJ Retailers
Trial Balance
as at 30th September 2006
Dr. Cr.
$ $
Accounts Receivable
Oren Peters SL 111.30
Malika Diantha SL 350.85
Accounts Payable
A.M. Bryden PL 89.80
AJ Wholesale PL 103.80
J Smith PL 1,500.00
Sales GL 823.85
Purchases GL 521.60
Sales Return GL 209.70
Purchases Return GL 153.00
Cash CB 302.00
Equipment GL 1,200.00
Motor Van GL 2,500.00
Capital GL 3,150.00
Bank CB 625.00
5,820.45 5,820.45

Take not that both columns of your trial balance are equal. The information is recorded on
the same side as the balances b/d in the ledger accounts. If your trial balance included
expenses and revenue your expenses would be recorded in the debit column and revenue
in the credit column.

TOPIC SUMMARY
Upon completion of this topic you should be able to balance your accounts. In addition you
should be able to describe how to use the trail balance to help analyze your business
activities.


UNIT SUMMARY
We have now completed the bookkeeping stage of the accounting process with our trial
balance. Now that you have completed unit two take some time to review the content in
both Units One and Two before you proceed to unit 3. It is very important that you fully
understand the contents in these two units if you are to understand the information in the
upcoming units. Also, review the activities and assignments and check your answers with
the answers given.

At this stage you should be able to identify source document and transfer the information
to the different books of original entry. You should also be able to post to you ledgers and
balance them off and transfer those balances to the Trial Balance. The next step is to
examine the adjustments necessary to ensure that your Financial Statements represents a
true and fair view of your business.

Self-Reflection Questions

Now that you have completed Unit Two take some time to review the content in
both Units One and Two before you proceed to Unit 3. Reflect on these questions:

1. Do I know who are my accounts receivable and accounts payable?

2. Are you able to distinguish between accounts payable and accounts
receivable?

3. Do you know the entries necessary to increase or decrease the amount on
account based on the type of accounts?

4. Do you understand when different types of accounts should be debited and
when it should be credited?

UNIT ASSIGNMENT
Unit 2 Assignment D

You can now complete the unit assignment by preparing the Trial Balance from the
balances on your ledger accounts.


UNIT REFERENCES
Holdip, G., & Lamorell, C. (2010). Principles of Accounts for CSEC Examinations.

Wood, F., & Robinson, S. (2007). Principles of Accounts for the Caribbean (5th ed.).
England, Pearson Education Limited.

http://www.accountingunplugged.com/2008/08/27/accounting-basics/

http://en.wikipedia.org/wiki/Credit_note

http://www.printablecashreceipts.com/

http://www.wisegeek.com/what-is-a-cash-receipt.htm

http://en.wikipedia.org/wiki/Cheque

http://www.scribd.com/doc/7216082/Unit-I-Accounting-for-Merchandising-Business1

http://www.peoi.org/Courses/Coursesen/ac/fram9.html

http://www.investorwords.com/46/account_balance.html#ixzz1HDhSFNDR

http://www.helium.com/items/1740700-how-to-balance-a-ledger-account


UNIT THREE – FINANCIAL ACCOUNTING AND ADJUSTMENTS
INTRODUCTION
In this unit you will look at the adjustments necessary before your financial statements can
be prepared. You would look at the adjustments for prepaid and accrued expenses and
revenue, depreciation and disposal of assets, bad debts and provision for bad debts. You
will also take a look at the various methods to value closing stock.

OBJECTIVES

1. Determine the various adjustments necessary before financial statement can be
prepared.
2. Make the necessary adjustments for accrued and prepaid expense and revenue
accounts.
3. Make adjustments for the depreciation and disposal of fixed assets.
4. Make adjustments for bad debts and provision for bad debts.
5. Identify and prepare different types of financial statements.
6. Illustrate the different layouts for financial statements.

UNIT READINGS



TOPIC 3.1 DEPRECIATION AND DISPOSAL OF ASSETS
INTRODUCTION
There is a time period attached to the useful life of all assets owned by a business. Since
assets depreciates in value as it is being used it can no longer be valued at cost price. In this
topic you will calculate depreciation and determine the disposal value of assets.

OBJECTIVES

1. Define depreciation.
2. State reasons for depreciating assets.
3. Identify methods of calculating depreciation.
4. Determine book value and disposal value of assets.
5. Examine the different methods of calculating depreciation (straight line and
diminishing balance method).
6. Show the treatment of depreciation in the financial statements.

WHAT IS DEPRECIATION?
Let us begin by defining depreciation. According to Woods and Robinson (2007),
Depreciation is the part of the original purchase cost of a fixed asset consumed during its
period of use by the business. It is an expense for services consumed and will be charged to
the income statement and will therefore, reduce net profit.

Depreciation is a process of allocation, not valuation. Eventually, all assets except land wear
out or become so inadequate or outmoded that they are sold or discarded; therefore, firms
must record depreciation on every plant asset except land. They record depreciation even
when the market value of a plant asset temporarily rises above its original cost because
eventually the asset is no longer useful to its current owner.

CAUSES OF DEPRECIATION
Major causes of depreciation are:

physical deterioration,
inadequacy for future needs, and
obsolescence.

Physical deterioration results from the use of the asset—wear and tear—and the action of
the elements. For example, an automobile may have to be replaced after a time because its
body rusted out.


Inadequacy of a plant asset is its inability to produce enough products or provide enough
services to meet current demands. For example, an airline cannot provide air service for
125 passengers using a plane that seats 90.

Obsolescence of an asset is its decline in usefulness brought about by inventions and
technological progress. For example, the development of the xerographic process of
reproducing printed matter rendered almost all previous methods of duplication obsolete.

To compute depreciation expense, accountants consider four major factors:

COST OF THE ASSET
Estimated salvage value of the asset. Salvage value (or scrap value) is the amount of
money the company expects to recover, less disposal costs, on the date a plant
asset is scrapped, sold, or traded in.
Estimated useful life of the asset. Useful life refers to the time the company owning
the asset intends to use it; useful life is not necessarily the same as either economic
life or physical life. The economic life of a car may be 7 years and its physical life
may be 10 years, but if a company has a policy of trading cars every 3 years, the
useful life for depreciation purposes is 3 years. Various firms express useful life in
years, months, working hours, or units of production. Obsolescence also affects
useful life.
Depreciation method used in depreciating the asset. We describe the four common
depreciation methods in the next section.

HOW IS DEPRECIATION CALCULATED?
In order to have free and fair view of the Balance Sheet it is important that the assets on
the balance sheet are correctly valued.

Today, businesses can use many different methods to calculate depreciation on assets. This
section discusses and illustrates the two most common methods—straight-line, and
reducing balance method.

According to accounting theory, a business should use a depreciation method that reflects
most closely their underlying economic circumstances. Thus, businesses should adopt the
depreciation method that allocates asset cost to accounting periods according to the
benefits received from the use of the asset.

Before studying some of the methods that companies use to depreciate assets, make sure
you understand the following definitions.

Useful life is an estimate of the productive life of an asset. Although usually
expressed in years, an asset's useful life may also be based on units of activity, such
as items produced, hours used, or miles driven.


Salvage value equals the value, if any that a company expects to receive by selling
or exchanging an asset at the end of its useful life.
Depreciable cost equals an asset's total cost minus the asset's expected salvage
value. The total amount of depreciation expense assigned to an asset never
exceeds the asset's depreciable cost.
Net book value is an asset's total cost minus the accumulated depreciation
assigned to the asset. Net book value rarely equals market value, which is the price
someone would pay for the asset. In fact, the market value of an asset, such as a
building, may increase while the asset is being depreciated. Net book value simply
represents the portion of an asset's cost that has not been allocated to expense.
(CliffsNotes.com. Depreciation of Operating Assets. 18 Apr 2011)

STRAIGHT-LINE DEPRECIATION
This is the method most commonly used by businesses for financial reporting. In this
method the assets annual depreciation expense is calculated by dividing the assets cost by
the number of years of useful life of the assets. Equal amount is transferred to the income
statement for depreciation each year. The assumption is that each accounting period
equally benefits from the use of the asset. The straight line method calculates an annual
charge by:

using a formula; or

applying a fixed percentage to the depreciable amount of the asset.

Straight-line Depreciation Formula

Depreciation = Cost - Scrap Value
Number of years

Cost – cost of the asset
Scrap Value – the business’s best estimate of the worth of the assets at the end of
its useful life
Numbers of years – the years the asset is expected to be useful to the business.

The fixed percentage is calculated by dividing 100% by the number of years of useful life

5 years of useful life 100 = 20 %
5


Example 3.1 A

On the 1st January 2011, a business purchases a Motor Vehicle for $50,000. It is
expected to give five years of service after which it will be sold for $5,000. Calculate
the annual depreciation to be charged to the income statement for each of the five
years.

Depreciation = Cost - Scrap Value
Number of Years
= 50, 000 - 5, 000
5
= 45,000
5
= $9,000
$9,000 will be charge to the Income Statement for depreciation annually.

Using the fixed percentage

100 = 20%
5
45,000 x 20% = 9,000

The following table summarizes the application of straight-line depreciation during the
Motor Vehicle five-year useful life.

Straight-Line Depreciation
Year Ending Depreciable Annual Accumulated
Net Book Value
31 December Cost Depreciation Depreciation
2011 50,000 9,000 9,000 41,000
2012 50,000 9,000 18,000 32,000
2013 50,000 9,000 27,000 23,000
2014 50,000 9,000 36,000 14,000
2015 50,000 9,000 45,000 5,000

At the end of year five, the $45,000 shown as accumulated depreciation equals the asset's
depreciable cost, and the $5,000 net book value represents its estimated salvage value.

To record depreciation expense on the Motor Vehicle each year, the company debits
depreciation expense–vehicles for $9,000 and credits accumulated depreciation–vehicles
for $9,000.


REDUCING BALANCE METHOD
In this method also called the diminishing balance, a different amount is charged to the
Income Statement each year for depreciation. A fixed percentage is applied to the net book
value of the asset at the beginning of each year. The net book value reduces as the asset
ages and the depreciation charge diminishes

Example 3.1 B

Looking at the same example above of a business that purchases a Motor Vehicle for
$50,000. If the reducing balance is used at a fixed percentage of 20% per annum.
Calculate the annual depreciation to be charged to the income statement for each of
the five years.

Reducing Balance Depreciation
Year Ending Depreciable Net Book
Depreciation
31 December Cost Value

2011 50, 000.00 10,000.00 40,000.00

2012 40,000.00 8,000.00 32,000.00

2013 32,000.00 6,400.00 25,600.00

2014 25,600.00 5,120.00 20,480.00

2015 20,480.00 4,096.00 16,384.00

Year 1 50,000 x 20 % = 10,000 Net Book Value 50,000 – 10,000 = 40,000

Year 2 40, 000 x 20% = 8,000 Net Book Value 40,000 - 8,000 = 32,000

The table below summarizes the application of reducing balance of depreciation during
the Motor Vehicle five-year useful life.

In this method the depreciation was charge yearly to the net book value of the asset.

RECORDING DEPRECIATION
Usually separate records of the cost of each type of non-current asset and the accumulating
depreciation on each type of non-current assets are kept. The provision for depreciation
account is updated at the end of each financial year with the annual depreciation charge.
This is done as follows:

Record the annual depreciation charge in the general journal


Post the journal entries to the accounts
o Debit Profit & loss Account
o Credit Provision for Depreciation Account

The Profit & loss account section of the income statement is debited with the depreciation
to ensure that profits are reduced for the year under review. The credit entry in the
provision account has the effect of reducing the value of the non-current asset. (Austen et
al 2011)

Let us now prepare the double entry records for the reducing balance example above.

Example 3.1 C

At the end of each year prepare the journal entries to record the depreciation to be
charged for the year as indicated below.

Journal
Date Details Dr Cr
$ $
31 Dec. 2011 Profit & loss 10,000.00
Provision for Depreciation 10,000.00

31 Dec. 2012 Profit & loss 8,000.00

31 Dec. 2013 Profit & loss 6,400.00

31 Dec 2014 Profit & loss 5, 120.00
Provision for Depreciation 5, 120.00

31 Dec. 2015 Profit & loss 4,096.00

The journal entries are then posted to the accounts.


Example 3.1 D

Motor Vehicle
2011 $ 2011 $
1-Jan Bank 50,000 31-Dec Balance c/d 50,000
2012 2012
1-Jan Balance b/d 50,000 31-Dec Balance c/d 50,000
2013 2013
2014 2014
2015 2015

Profit & loss Account (extract) for the year ended 31 December
$
2011 Depreciation 10,000.00

Provision for Depreciation of Motor Vehicle
2011 $ 2011 $
31-Dec Balance c/d 10,000 31-Dec Profit & loss 10,000
2012 2012
31-Dec Balance c/d 18,000 1-Jan Balance b/d 10,000
31-Dec Profit & loss 8,000
18,000 18,000
2013 2013
24,400 24,400
2014 2014
29,520 29,520
2015 2015
31-Dec Profit & loss 4096
33,616 33,616


How Does Depreciation Affect the Balance Sheet?

The balance sheet at the end of each financial year should show the noncurrent assets at
cost less the balance on the provision for depreciation account. At the end of each year
that year’s depreciation is charged to the Profit & loss account but it is the accumulated
depreciation to date that is charged to the balance sheet. Let’s have a look at the balance
sheet extract for the example above.

Example 3.1 E

Balance Sheet (extract) as at 31 December 2011
Cost Accumulated Depreciation Net Book Value
$ $ $
Motor Vehicle 50,000 10,000 40,000

$ $ $
Motor Vehicle 50,000 18,000 32,000

$ $ $
Motor Vehicle 50,000 24,400 25,600

$ $ $
Motor Vehicle 50,000 29,520 20,480

$ $ $
Motor Vehicle 50,000 33,616 16,384

The Sale of an Asset

When an asset is sold it should be deleted from your records. This is done by take out the
cost from the asset account, the amount of accumulated depreciation removed from the
provision for depreciation account, and then the profit or loss on sale is calculated. These
entries are record in the asset disposal account.


The Account Entries Needed

On the sale of non-current asset, example Motor Vehicle, the following entries are needed.

1. Transfer the cost of the asset to be sold to an asset disposal account (for this example a
Motor Vehicle Disposal Account).

Debit Motor Vehicle Disposal Account
Credit Motor Vehicle Account

2. Transfer the accumulated depreciation to the asset disposal account.

Debit Provision for Depreciation – Motor Vehicle
Credit Motor Vehicle Disposal Account

3. Record the funds received from the sale of the asset.

Debit Cash Book

4. Transfer the balance on the asset disposal account to the Profit & loss account.

a) If the Motor Vehicle Disposal Account show a balance on the debit side of the
account then it is a profit on sale.

Debit Motor Vehicle Disposal Account
Credit Profit & loss Account

b) If the Motor Vehicle Disposal Account shows a balance on the credit side of the
account then it is a loss on sale.

Debit Profit & loss Account

Now let us assume that the motor vehicle in the example above was disposed of at the end
three years. Assume that on the 1st January 2014 the Motor Vehicle was sold for $20,000
by cheque, then the following entries would be made to record this disposal.


Motor Vehicle
2011 $ 2011 $
1-Jan Bank 50,000 31-Dec Balance c/d 50,000
2012 2012
2013 2013
2014 2014
Motor Vehicle Disposal
1-Jan Balance b/d 50,000 1-Jan Account 50,000

Provision for Depreciation of Motor Vehicle
2011 $ 2011 $
31-Dec Balance c/d 10,000 31-Dec Profit & loss 10,000
2012 2012
18,000 18,000
2013 2013
24,400 24,400
2014 2014
1-Jan Motor Vehicle Disposal
Account 24,400 1-Jan Balance b/d 24,400

24,400 24,400

Example 3.1 F

Cash Book

Date Cash Bank Date Cash Bank
2014 $ $ 2014 $ $

1-Jan Motor Vehicle Disposal 20,000


Motor Vehicle Disposal Account
2014 $ 2014 $
1-Jan Motor Vehicle 50,000 1-Jan Provision for Depreciation 24,400
1-Jan Cash Book 20,000
1-Jan Profit & loss (loss on Sale) 5,600
50,000 50,000

Profit & loss Account (extract) for the year ended 31 December 2014
$
Gross Profit x xxxx
Less Loss on sale of
Motor Vehicle 5,600

TOPIC SUMMARY
You have just looked at the entries necessary to record depreciation of non-current assets
and the disposal of non-current assets. You should remember that the depreciation for the
current year is charged to Profit & loss account but the accumulated depreciation is
charged to the balance sheet each year.

You will now continue by look at other necessary adjustment that are required before the
final accounts can be prepared.


TOPIC 3.2 ADJUSTMENTS FOR FINANCIAL REPORTING
INTRODUCTION
In order to give true and fair view of your financial statement there are adjustments
required to account for prepaid and accrued expenses and revenue. These adjustments
should be dealt with before you proceed to your financial statements.

OBJECTIVES
Upon completion of this topic you should be able:

1. Define the terms accrued and prepaid.
2. Make the necessary adjustment to expense and revenue accounts.
3. Account for these adjustments in the financial statements.
4. Understand why it is necessary to adjust expense and revenue accounts for amounts
accrued or prepaid.

MAKING ADJUSTMENTS
So far we have assumed that all the expense and revenue incurred are for the present
financial period. However there are instances where the amounts paid for expense or
received for revenue would be for the previous financial period (accrued) or the upcoming
financial period (prepaid). When this happens the figure charged to the financial
statements for this period need to be adjusted to reflect the accrued or prepaid amounts.

Let’s first look at the entries necessary for accrued and prepaid expenses. Let us assume
that two businesses paid rent for the premises $8,000 by cheque per year. For the year
2011 the following accrued

Business A pays $6,500 during the year and owes $1,500 at the end of the year

Rent for the year $8,000

Rent paid $6,500

Rent owed $1,500

Business B pays $9,000 during the year which includes $1,000 prepaid for the following
year.

Rent for the year $8,000

Rent paid $9,000

Rent prepaid $1,000


ACCRUED EXPENSES (EXPENSES OWING)
Remember that expenses are the cost of doing business for example salary, rent, utilities,
carriage outwards, discount allowed and interest on money borrowed. From the example
above the amount that should be debited to the Profit & loss account for rent should be
$8,000 since that is amount that should be used up for this period.

Example 3.2A

Business A

Rent Account
Date Details folio Amount Date Details Folio Amount
2011 $ 2011 $
31-Dec Bank CB 6,500 31-Dec Profit & Loss 8,000
31-Dec Accrued c/d 1,500
8,000 8,000
2012 2012
Jan 1 Accrued b/d 1,500 1-Jan Accrued b/d 1,500

Profit & loss (extract) for year ended 31 December 2011
$ $
Rent 6,500

Current Liabilities $
Expenses Accrued 1,500
Add Rent Accrued 1,500 8,000

Observe that even though only $6,500 was paid for rent during the year the Profit & loss
should include the total amount that should have been paid for the year. Also observe that
accrued expense is added in the Profit & loss account. Accrued expenses are a liability to
your business therefore any accrued expenses should be shown as a current liability in your
balance sheet.

PREPAID EXPENSES
Let us now look at Business B and the entries necessary in your records to record prepaid
expenses. Remember that the amount that should be debited to the Profit & loss account
for rent is $8,000.


Example 3.2 B

Business B

Rent Account
2011 $ 2011 $
31-Dec Bank CB 9,000 31-Dec Profit & loss 8,000
31-Dec Prepaid c/d 1,000
9,000 9,000
2012
1-Jan prepaid b/d 1,000

$ $
Rent 9,000
Less Prepaid Rent 1,000 8,000

Current Assets $
Prepaid Expenses 1,000

Looking at the entries above you will see that prepaid expenses is subtracted in the Profit &
loss account and included in the current assets in the balance sheet.

We can now continue by looking at accrued and prepaid revenue. Remember that revenue
accounts are those accounts that bring income into the business, for example discount
received, interest received, rent received and commission received.

Let us look at two businesses that sublet their premises for $5,000 per year. In 2011 the
following accrued

Business C received $4200 by cheque for rent in 2011

Rent that should be received for the year $5,000

Rent received $4,200

Rent received owed for the year $ 800

Business D received $6,800 by cheque for rent in 2011

Rent that should be received for the year $5,000


Rent received $6,800

Rent received prepaid for the year $1,800

ACCRUED REVENUE (REVENUE OWING)
From our example the amount that should be credited to the Profit & loss account for rent
received is $5,000. Therefore the following entries are required to show the adjustment for
revenue owing.

Example 3.2 C

Business C

Rent Received Account
2011 $ 2011 $
31-Dec Profit & loss 5,000 31-Dec Bank CB 4,200
31-Dec Owings c/d 800
5,000 5,000
2012
1-Jan Owings b/d 800

$ $
Gross Profit xxxx
Add Revenue
Rent Received 4,200
Add Owings 800 5,000

Current Assets $
Revenue owing 800

Take note that revenue is added to the gross profit in the Profit & loss account and that
revenue owing is recorded as a current asset in the balance sheet.

PREPAID REVENUE
Observe in the entries below that prepaid revenue is recorded as a current liability in the
balance sheet.


Example 3.2 D

Business D

Rent Received Account
2011 $ 2011 $
31-Dec Profit & Loss 5,000 31-Dec Bank CB 6,800
31-Dec Prepaid c/d 1,800
6,800 6,800
2012
1-Jan Prepaid b/d 1,800

$ $
Gross Profit xxxx
Add Revenue
Rent Received 6,800
Less Prepaid 1,800 5,000

Current Liabilities $
Revenue prepaid 1,800

There is a credit entry in the rent received account above to indicate the cash received for
the rent the debit entry is recorded in the cash book since the funds was received by the
business.

TOPIC SUMMARY
There are number of things to remember from this topic

1. Accounts should be adjusted at the end of each period to account for any
prepayments or accruals during the period.
2. Accruals are added in the Profit & loss account while prepayments are subtracted.
3. In the balance sheet prepaid expenses and revenue owing is included in the current
assets while expenses owing and revenue prepaid are included in the current
liabilities


TOPIC 3.3 BAD DEBTS AND PROVISION FOR BAD DEBTS
INTRODUCTION
Once a business decides to offer its goods and/or services on credit to its customers that
business has to be prepared for some of its customers not paying for the goods and/or
services they received. When this occurs the necessary adjustment should be made to
account for these unpaid debts. In accounting when a business is unable to collect the
amount due from its customers the amounts owed should be transferred to a bad debts
account. In this topic you will look at bad debts and provisions that should be made for bad
debts in your business.

OBJECTIVES
Upon the completion of this topic you should be able to:

1. identify a bad debt;
2. describe how bad debts are written off;
3. explain how provisions for bad debts are made;
4. make accounting entries,
(a) to recorded bad debts and provision for bad debts,
(b) for increasing and reducing the provision for bad debts, and
(c) for bad debts recovered.

BAD DEBTS
When a business decides to sell its goods/services to customers for credit there is a
possibility of some of these customers not paying for the goods/services received. A
customer may not be able to pay because their business has suffered a loss or they may
have gone bankrupt. Bad debt is an expense to your business. Bad Debt is a debt that is
unlikely to be paid

Examine the following example.

Example 3.4 A

You sold goods on credit to M. Label for $500 on the 21 January 2011. On March 15, you
sold $725 goods on credit to J. Jackets. On the 1st June you received $375 by cash from M
Label and on the 30 August you received $650 by cheque from J Jackets. At the end of
your financial year you were notified that both M Label and J Jacket would not be able to
pay the balance of their debts. You then decide to write the debts off.


The following accounting entries are required:

Debit - Bad Debt Account - to transfer the amount of the unpaid debit.

Credit - Debtors Account - to reduce the liability for the debtor who is unable to pay.

_____________________________________________________________________

Debit - Profit & loss Account - to record the amount of bad debt for the accounting period.

Credit - Bad Debt Account - to transfer the amount of bad debt to the profit
and loss account.
___________________________________________________________________
Your accounts should be as follows:
M. Label
2011 $ 2011 $
21-Jan Sales GL 500 1-Jun Cash CB 375
31-Dec Bad Debts Account GL 125
500 500

J Jacket
2011 $ 2011 $
15-
Mar Sales GL 725 30-Aug Bank CB 650
31-Dec Bad Debts Account GL 75
725 725

Bad Debts Account
2011 $ 2011 $
31-Dec M. Label SL 125 31-Dec Profit & loss a/c 200
31-Dec J. Jacket SL 75
200 200

$ $
Gross Profit xxxx
Less Expenses
Bad Debts 200

PROVISION FOR BAD DEBTS

Because your business sell goods to its customers on credit you should make provision for
the likely hood that some of customers will not pay their debt in full. A provision for bad
debts account is created to show the estimated amount of debts that your business may
not be able to recover. The amount for provision for bad debts can be estimates as follows

By looking at each debt and estimate which one will be bad
On the basis of experience estimate what percentage of the debts will result in bad
debts

Normally a business decides what percentage of its debtors at the end of financial year it
would estimate as being unrecoverable. Once the percentage is decide then the accounting
entries are required

In the first year:

Debit - Profit & loss Account with the amount of the provision
Credit - Provision for Bad Debts Account

Increase in Provision of Bad Debts Amount

In the years that follows if the amount of the provision is greater than the year before then the
difference between both years is recorded as follows

Debit - Profit & loss Account (with the difference between previous and present
year)
Credit - Provision for Bad Debts (with the difference between the previous and
present year)

Decrease in Provision of Bad Debts Amounts

If the amount of the provision is less than the previous year the entries would be

Debit - Provision for Bad Debts (with the difference between the previous & present year)

Credit - Profit & loss Account (with the difference between previous and present year)

Example 3.4 B

A business estimates that 2% of its debtors at the end of each year will be bad debts. The
debtors figure for that business for the years 2011 – 2013 are:
2011 Debtors $ 10,000
2012 Debtors $ 12,000
2013 Debtors $ 8,000

Show the accounting entries necessary to record the above.

The calculation is shown in the table below:


Provision Provision Profit &
Year Debtors Percentage Amount Loss
$ % $ $
2011 10,000 2 200 200
2012 12,000 2 240 40
2013 8,000 2 160 80

You can how show the accounting entries to record these calculations

Provision for Bad Debts Account
2011 $ 2011 $
31-Dec Balance c/d 200 31-Dec Profit & Loss a/c 200
2012 2012
31-Dec Balance c/d 240 1-Jan Balance b/d 200
31-Dec Profit & Loss a/c 40
240 240
2013 2013
31-Dec Profit & Loss a/c 80 1-Jan Balance b/d 240
31-Dec Balance c/d 160
240 240
2014
1-Jan Balance b/d 160

Profit & loss (extract) for year ended 31 December 2011 - 2013
$ $
2011 Provision for Bad Debts 200


Balance Sheet (extract) as at 31 December 2011 - 2013
$ $
2011 Debtors 10,000
Less Provision for bad debts 200 9,800
2012 Debtors 12,000
2011 Debtors 8,000


Take note that a reduction in the provision for bad debts is revenue to your business and
should be added to your gross profit. Also note that the balance on the provision for bad
debts account at the end of each financial period is subtracted from the debtors figure in
the balance sheet.

Let now look at fully worked example:

Example 3.4 C
A business started on 1 January 2005 and its financial year end is 31 December annually.
The table of the debtors, the bad debts written off and the estimated provision for bad
debts at the end of the year is:

Bad Debts Provision for Bad
Year Debtors written off Debts Amount
$ $ $
2005 12,000 298 100
2006 15,000 386 130
2007 14,000 344 115
2008 18,000 477 150

You are required to show the bad debts account and the provision for bad debts account,
as well as the extracts from the Profit & loss account for each year and the balance sheet
extracts.

The double entry records to show the above is as follows

Provision for Bad Debts
2005 $ 2005 $
31-Dec Balance c/d 100 31-Dec Profit & loss a/c 100
2006 2006
31-Dec Profit & loss a/c 30
130 130
2007 2007
31-Dec Profit & loss a/c 15 1-Jan Balance b/d 130
31-Dec Balance c/d 115
130 130
2008 2008
31-Dec Profit & loss a/c 35


150 150
2009 2009
1-Jan Balance b/d 150

Profit & loss Account (extracts) for the year ended 31 December
$ $
2005 Bad Debts 298
Provision for Bad Debts 100

2006 Bad Debts 386

Reduction in Provision for Bad
2007 Bad Debts 344 Debts 15

2008 Bad Debts 477


Balance Sheet (extract) as at 31 December
$ $
2005 Debtors 12,000
Less Provision for Bad Debts 100 11,900

2006 Debtors 15,000

2007 Debtors 14,000

2008 Debtors 18,000

There are instances where bad debts that are written off are recovered in the future.
When this occur the debt should be reinstate by:

Debit - Debtors Account
Credit - Bad Debts recovered Account

When cash or a cheque is received from the debtor in settlement of the account the entries
should be:

Debit - Cash Book
Credit - Debtors Account

TOPIC SUMMARY
You just looked at the accounting entries required to bad debts and provision for bad debts.
You should remember that after the first entry for provision for bad debts in the Profit &
loss account the difference between the previous year and the present year is recorded in
the Profit & loss account. Note that balance on the provision for bad debts account at the
end of the financial period is deducted from the balance on the debtors account in the
balance sheet. You should also remember that a reduction in the provision of bad debts is
revenue to your business and should be added to your gross profit while an increase is an
expense and should be deducted from your gross profit.


TOPIC 3.4 INVENTORY ACCOUNTING
INTRODUCTION
At the beginning and end of every period there will be items of stock remain on your selves
and in your warehouse. These stocks have to be valued and accounted for in the financial
statements. In this topic we will look at the valuation of stock and the various methods of
valuing closing stock.

OBJECTIVES
Upon the completion of this topic you should be able to:

1. Identify different methods of stock valuation.
2. Examine different methods of stock valuation (LIFO, FIFO, AVCO).
3. Illustrate the different adjustment required to arrive at the closing stock.
4. Show how the necessary adjustments are recorded in the financial statements.

STOCK VALUATION
Stock are goods purchased for re-sale. Keeping a record of stock involves adding new stock
purchased and deducting any stock sold. Stocktaking (taking inventory) is the process of
physically checking stock. This involves physically counting the stock on hand and
comparing the findings with figures on the stock record. Stocktaking helps to assess the
amount of loss due to theft or breakage and ensure that ht stock records are being kept
effectively.

There are two ways that stock may be recorded by a business.

1. Perpetual method or continuous method where stocks are updated after each
purchase, sale or return of stock.
2. Periodic method where the closing stock figure is determined by physically counting
and valuing stock on hand at the end of a period.

Methods of Stock Valuation

There are three methods of valuing stock. These are:

1. First In First Out (FIFO) assumes that the first set of stocks purchased are the first set
of stocks that would be sold.
2. Last In First Out (LIFO) assumes that last set of stocks purchase are the first set of
stock that would be sold.
3. Average Cost (AVCO) values closing stock by using the average cost of the stocks
available for sale. This is done as follows:

Cost of goods available for sale


Average Cost = number of units available for sale

You can now examine the valuation of closing stock using each method in the example
below.

Example 3.4 A

For 2011 the receipt and issue of stocks are as follows

Receipt Sales

Jan 20 items at $30 each June 6 items for $45 each

May 10 items at $33 each Aug 22 items for $46 each

July 16 items at $38.50 each Dec 10 items for $48 each

Oct 12 items at $39 each

There was no opening stock.

Calculate the closing stock using (i) FIFO (ii) LIFO (iii) AVCO.
Draw up the trading account for the year ended 31 December 2011 showing the
different reported gross profits from the figures given in (a)

Stock after each
FIFO Received Issued $ $
transaction
January 20 @ $30 20 @ $30 600
20 @ $30 600
May 10 @ $33 930
10 @ $33 330
14 @ $30 420
June 6 @ $30 750
10 @ $33 330
14 @ $30 420
July 16 @ 38.50 10 @ $33 330 1,366
16 @ $38.50 616
14 @ $30 2 @ $33 66
August 682
8 @ $33 16 @ $38.50 616
2@ $33 66
October 12 @ $39 16 @ $38.50 616 1,150
12 @ 39 468
2 @ $33 8 @ $38.50 308
December 682
8 @ $38.50 12 @ $39 468


Take note that the first items of stock purchased are the first to be sold. Also note that
stock is valued at cost price not at selling (sales) price. The valuation of stock should not
include profit amounts.

Stock after each
LIFO Received Issued $ $
transaction
January 20 @ $30 20 @ $30 600

20 @ $30
May 10 @ $33 600 930
10 @ $33
330
20 @ $30 600
June 6 @ $33 732
4 @ $33 132
20 @ $30 600
July 16 @ 38.50 4 @ $33 132 1,348
16 @ $38.50 616
16 @ $38.50
August 4 @ $33 18 @ $30 540
2 @ $30
18 @ $30 540
October 12 @ $39 1,008
12 @ $39 468

18 @ $30 540
December 10 @ $39 618
2 @ $39 78

You can observe that when the LIFO method of valuation is used the last item of stock
received becomes the first item of stock to be issued.

Average Cost per Number of Value of
AVCO Received Issued
unit units stock
$ $
January 20 @ $30 30 20 600

30 + 33 = 31
May 10 @ $33 930
10 + 20 30

June 6 @ $31 31 24 744

31 + 38.50
July 16 @ 38.50 40 1,360
24 + 16 = 34

August 22 @ $34 34 18 612

34 + 39
October 12 @ $39 30 1,080
40 + 12 = 36


Average Cost per Number of Value of
AVCO Received Issued
unit units stock

December 10 @ $36 36 20 720

You can move on to look at the trading account taking into account the different valuations
of stock just calculated.

Trading Account for the year ended 31 December 2011
FIFO LIFO AVCO
$ $ $ $ $ $
Sales 1,762 1,762 1,762
Less Cost of Goods Sold
Purchases 2014 2014 2014
Less Closing
Stock 776 1,238 618 1,396 729 1,294
Gross Profit 524 366 468

The sales figure is calculated by adding all the sales

June 6 x 45 270
August 22 x 46 1,012
December 10 x 48 480
1,762

The purchase figure is calculated by adding all the purchase amounts

January 20 x 30 600
May 10 x 33 330
July 16 x 38.50 616
October 12 x 39 468
2014

The use of different methods of valuation of stock would give a different value of gross
profit and net profit for the same business.

TOPIC SUMMARY
You just observed that different methods can be used to value closing stock. You would
have noted that these different methods of valuation have a different effect on the profit
calculation.


TOPIC 3.5 FINAL ACCOUNTS FOR SOLE TRADER
INTRODUCTION
So far in this unit you have looked at different adjustment needed before the final accounts
can be prepared. The final accounts for a sole trader business are the Income Statement
(Trading and Profit & loss Account) and the Balance Sheet. The final accounts give a picture
of the financial position of your business. It shows where or not your business has made a
profit or loss during the accounting period and whether you are able to pay your debts as
they become due. Let’s now have a look at the final accounts of a sole trader business.

OBJECTIVES
Upon the completion of this topic you should be able to;

1. understand how profit/loss is calculated,
2. calculate the cost of goods sold, gross profit and net profit,
3. transfer net profit and drawings to the capital account at the end of the period, and
4. prepare an Income Statement from a trial balance.

FINAL ACCOUNTS
After your trial balance is completed your final accounts are prepared. The final accounts
of a sole trader business include the Income Statement (trading and Profit & loss account)
and the balance sheet. Remember that your trial balance is the summary of the balances in
all your accounts. Some of these balances (those from your nominal accounts) affect the
profit and are transferred to the Income statement; the others (real and personal accounts)
are transferred to your balance sheet. The Income Statement and the Balance Sheet are
prepared at the end of each financial period to record how well the business operated
during that financial period.

Income Statement

One of the most important financial statements of any business is the Income Statement. It
is used to determine the following:

1. how profitable a business is being run; and
2. comparing the results received with the results expected.

The Income Statement can be divided into two sections the trading account and the Profit
& loss account. The gross profit which is the amount of profit made before the expenses
are deducted is calculated in the trading account. The purpose of the trading account is to
determine the gross profit made from sales. Therefore the accounts that are directly
related to buying and selling (trading) will be transferred to the trading account. The
accounts directly related to trading are:

Sales


Purchase
Sales Return
Purchases Return
Carriage Inwards

Gross profit is calculated as:

Gross Profit = Net Sales – Cost of Goods Sold (COGS)

Along with gross profit the net sales, cost of goods sold and the cost of goods available for
sale is also calculated in the trading account:

Net Sales = Sales – Sales Return (Return Inwards)

Net sales are the total sales figure after allowances have been made for sales returned to
the business.

COGS = Cost of goods available for sale (COGAFS) – Closing Stock

COGAFS = Opening Stock + (Purchases – Purchases Return) + Carriage Inwards

The net profit of your business is calculated in the Profit & loss account. Net profit is the
balance of profit after allowance is made for revenue and expenses. It is calculated as:

Net Profit = Gross profit + Revenue – expenses

The revenue and expense charged to the Profit & loss account are those that are not
directly related to trading but more to do with the running of the business. Some of these
accounts are:

Rent
Telephone
Carriage outwards
Discount allowed
Discount received
Commission received
Commission paid
Salary

In Unit Two these accounts were closed off and transferred to the income statement. The
income statement can be shown horizontally or vertically.


BALANCE SHEET
The other half of our final accounts is the Balance Sheet. The Balance Sheet is a financial
statement showing the book values of the assets, liabilities and capital at the end of the
financial period. It shows what the business owes and what it owns.

The assets of the business is divided into two categories and recorded as follows

1. Non-Current Assets are assets that:

are expected to be of use in the business for long time;
are to be used in the business; and
were not bought only for the purpose of resale.

Non-current assets are recorded in the balance sheet starting with those assets that
will in the business the longest down to those that will be kept for a shorter period.
Example of non-current assets and the order of record are:

Land and Buildings.
Fixtures and Fittings.
Machinery.
Motor Vehicles.

2. Current Assets are recorded next. These are assets will change within the next
twelve months. They are recorded as follows:

Stock (goods bought for resale)
Debtors.
Cash at Bank.
Cash in Hand.

3. Non-current Liability - Sometime referred to as long term liability are those debts
that take more than a year to settle. This includes large loans and mortgages.

4. Current Liability - are debts that will be settled in one year or less. This includes
creditors and small loans.

Let’s now prepare the final accounts from the trial balance on the next page.


Example 3.5A
MDAR Retailer
Trial Balance as at 31 December 2011
Dr. Cr.
$ $
Discount Allowed 410
Discount Received 506
Carriage Inwards 309
Carriage Outwards 218
Return Inwards 1,384
Return Outwards 810
Sales 120,320
Purchases 84,290
Stock 31 December 2010 30,816
Motor expenses 4,917
Repairs to premises 1,383
Pay 16,184
Sundry expenses 807
Rates and insurance 2,896
Premises at cost 40,000
Motor Vehicle at cost 11,160
Provision for depreciation motors as at 31 December 2010 3,860
Debtors 31,640
Creditors 24,320
Cash at bank 4,956
Cash in hand 48
Drawings 8,736
Capital 50,994
Loan from P. Holland 40,000
Bad Debts 1,314
Provision for bad debts as at 31 December 2010 658
241,468 241,468

The following should be considered on 31 December 2011
1) Stock $36,420
a) Expenses owing
b) Sundry expenses $62
2) Motor expenses $33
3) prepayments
a) Rates $166
4) Provision for bad debts to be reduced to $580
5) Depreciation for motors to be $2,100 for the year
6) Part of the premises were let to a tenant who owed $250 at 31 December 2011
7) Loan interest owing to P. Holland, $4,000
Prepare the Income Statement and Balance Sheet as at 31 December 2011.


Horizontal presentation of the Income Statement and Balance Sheet.

MDAR Retailer
Income Statement
for the year ended 31 December 2011
$ $ $ $
Opening Stock 30,816 Sales 120,320
Add Purchases 84,290 Less Sales Returns 1,384 118,936
Less Purchases Return 810 83,480
Add Carriage Inwards 309
COGAFS 114,605
Less Closing Stock 36,420
COGS 78,185
Gross Profit c/d 40,751
118,936 118,936
Less Expenses Gross Profit b/d 40,751
Motor Expenses 4,917 Add Revenue
Add Motor expenses
owing 33 4,950 Discount Received 506
Pay 16,184 Rent Receivable 250
Reduction in Provision
Carriage Outwards 218 for Bad Debts 78 834
Discount Allowed 410 41,585
Repairs to Premises 1,383
Sundry Expenses 807
Add sundry expenses
owing 62 869
Bad Debts 1,314
Rates and Insurance 2,896
Less prepaid rates and
insurance 166 2,730
Loan Interest 4,000
Depreciation: Motor 2,100
Net Profit 7,427
41,585 41,585


MDAR Retailer
Balance Sheet
as at 31 December 2011
Non-Current Assets $ $ $ Capital $ $ $
Premises at cost 40,000 Balance as at 1 Jan 2011 50,994
Motor Vehicle at cost 11,160 Add Net Profit 7,427
Less Depreciation to date 5,960 5,200 58,421
45,200 Less Drawings 8,736
Current Assets 49,685
Stock 36,420 Non-Current Liability
Debtors 31,640 Loan from P. Holland 40,000
Less Provision for Bad Debts 580 31,060 89,685
Prepaid Expense 166
Revenue owing 250 Current Liabilities
Cash at bank 4,956 Creditors 24,320
Cash in hand 48 72,900 Expenses owing 4,095 28,415
118,100 118,100

Vertical presentation of the Income Statement and the Balance Sheet.

The vertical presentation is the most common method of presenting final accounts today.
In the vertical presentation of the balance sheet the working capital is indicated. This is
calculated as:

Working Capital = Current Assets - Current Liabilities

The working capital indicates the liquidity of your business. This means the ability of your
business to pay its debts when they become due. It gives an idea of the amount of funds
available to run the business on a day to day basis.


MDAR Retailer
Income Statement
$ $ $
Sales 120,320
Less Sales Returns 1,384
Net Sales 118,936
Opening Stock 30,816
Add Purchases 84,290
Less Purchases Return 810 83,480
Add Carriage Inwards 309
COGAFS 114,605
Less Closing Stock 36,420
COGS 78,185
Gross Profit 40,751
Add Revenue
Discount Received 506
Rent Receivable 250
Reduction in Provision for Bad Debts 78 834
41,585
Less Expenses
Motor Expenses 4,917
Add Motor expenses owing 33 4,950
Pay 16,184
Carriage Outwards 218
Repairs to Premises 1,383
Sundry Expenses 807
Add sundry expenses owing 62 869
Bad Debts 1,314
Rates and Insurance 2,896
Less prepaid rates and insurance 166 2,730
Loan Interest 4,000
Depreciation: Motor vehicles 2,100 34,158
Net Profit 7,427


MDAR Retailer
Balance Sheet
Non-Current Assets $ $ $
Motor Vehicle at cost 11,160
Less Depreciation to date 5,960 5,200
45,200
Current Assets
Stock 36,420
Debtors 31,640
Prepaid Expense 166
Revenue owing 250
Cash at bank 4,956
Cash in hand 48
72,900
Current Liabilities
Creditors 24,320
Expenses owing 4,095 28,415
Working Capital 44,485
89,685

Financed by
Balance as at 1 January 2011 50,994
Add Net Profit 7,427
58,421
Less Drawings 8,736
49,685
Non-Current Liability
Loan from P. Holland 40,000
89,685


TOPIC SUMMARY
You have just examined the final account of a sole trader business. Remember that the
final accounts are made up of the income statement and the balance sheet. The income
statement can be further divided into a trading account and also a Profit & loss account.
You would have noted that the information to draw up the final accounts is taken from
your trial balance. Some of the information in your trial balance is transferred to the
income statement and others to the balance sheet.

A number of important information about your business is calculated in the income
statement. This included the gross profit/loss and net profit/loss of your business. These
indicate how well your business is running. Your balance sheet shows your assets in
relation to your capital and liabilities. In the vertical presentation of the balance sheet you
are able to calculate your working capital which is an indication of liquidity of your business.


UNIT SUMMARY
In this unit you had a look at adjustments that should be made to your accounts before
your final accounts are prepared. These adjustments included adjustments for depreciation
and provision for depreciation, bad debts and provision for bad debts, accrued and prepaid
expenses and revenue and also at the different valuation of closing stock. All these
adjustments are necessary if your final accounts are to present a true and fair view of your
business.

Once you would complete all the necessary adjustment your final accounts can be
prepared. Your final accounts include your income statement and balance sheet. Your
income statement comprise of your trading account where your gross profit/loss is
calculated and your Profit & loss account where your net profit/loss is calculated. You also
had a look at the two ways to present your final account the horizontal and vertical
presentations.

Now that you have completed the final accounts for a sole trader you will now continue by
analysing and interpreting these financial statements and have a look at the control
systems of a business in Unit 4.

UNIT REFERENCES
Austen, D., Ellis, D., et al (2011). Principles of Accounts for CSEC. United Kingdom, Nelson
Thornes Ltd.

Holdip, G., & Lamorell, C. (2010). Principles of Accounts for CSEC Examinations. Macmillan
Publishers Ltd.

Whitcomb, A., & Clarke, G., (202). Accounts for CSEC. United Kingdom, Heinemann
Educational Publishers

Wood, F., & Robinson, S. (2007). Principles of Accounts for the Caribbean (5th ed.). England,
Pearson Education Limited

CliffsNotes.com. Depreciation of Operating Assets. 18 Apr 2011

http://www.cliffsnotes.com/study_guide/topicArticleId-21081,articleId-21076.html

http://docs.globaltext.terry.uga.edu:8095/anonymous/webdav/Accounting%20Principles/A
ccounting%20Principles%20Vol.%201.pdf


UNIT FOUR – ANALYSING/INTERPRETING FINANCIAL STATEMENTS
AND CONTROL SYSTEMS

INTRODUCTION
In this unit you will analyse and interpret the information in the financial statements.
Earlier you learnt that the financial statements are used by different persons for various
reasons. You can tell a lot about a business by looking at its financial statements, however
to get a true picture of the performance of your business these record can be further
analysed by the use of different ratios and formulas. We would have a more in-depth look
at the financial statements of a business in this unit. You will also have a look at control
systems that business put in place to monitor various aspects of their business

OBJECTIVES
Upon completion of this unit you will be able to:

1. identify ratios that can analyse the performance of sole trader business;
2. state he formula to be used when calculating accounting ratios;
3. calculate ratios based on the end of period financial statements;
4. calculate and analyse ratios on profitability, liquidity and efficiency to assess your
business performance;
5. employ accounting ratios to calculate missing figures in financial statements;
6. explain why the petty cash book is used;
7. describe the imprest system;
8. list the need for control accounts;
9. examine the double entry aspect of control accounts;
10. reconcile cash book balances with bank statement balances;
11. state the reasons for preparing bank reconciliation statement;
12. list the functions of the payroll;
13. calculate employees’ pay using various methods;
14. distinguish between statutory and non-statutory deductions;
15. complete the payroll and wage documents from time cards;
16. distinguish between the different types of errors; and
17. correct errors using the journal.

UNIT READINGS



TOPIC 4.1 ACCOUNTING RATIOS
INTRODUCTION
There are a number of ratios used to analyse and interpret the performance of a business.
They are valuable means of comparing the performance of your business. These ratios can
be classified as trading account ratios, profit and loss ratios and balance sheet ratios. In this
topic we will examine each of these ratios.

OBJECTIVES
Upon completion of this lesson you will be able to:

1. identify ratios that can be used to analyse the performance of your business;
2. calculate ratios based on the end of year financial statements;
3. state the formulas to be used when calculating accounting ratios; and
4. calculate and analyse ratios on profitability, liquidity and efficiency to assess a
business’s performance.

INTERPRETATION OF ACCOUNTS
In order to assess the performance of business, financial information is recorded, classified
and communicated to the different users of accounting information. The financial
information can be evaluated by the use of accounting ratios. Ratios provide a valuable
means of comparing the performance of a business

From one year to the next
With other similar businesses

They enable changes in important aspects of a business’s performance to be pinpointed
and quantified. If ratios are calculated every year, it is possible to see whether any
significant trends are becoming apparent. (David, A., et al 2011)

An important factor in a business is to ensure that it operates at a profit and that it can pay
its creditors and expenses when they become due. The ability for a business to pay its
debts when they become due is known as liquidity and the ability to make a profit is known
as profitability.

We will have a look at the profitability and liquidity ratios and which part of the financial
statement should be used to calculate these ratios.


TRADING ACCOUNT RATIOS
Accounting ratios that uses the information from your trading account can be classified as
trading account ratios. These ratios are

1. Margin which is gross profit is shown as a percentage of selling price

Gross Profit x 100
Selling Price

2. Mark-up is gross profit shown as a percentage of cost price

Gross Profit x 100
Cost Price

3. Rate of stock turnover or stock turn measures quickly a business sells its goods
without losing its profitability.

Cost of goods sold = stock turnover
Average stock

Average stock = opening stock + closing stock
2

4. Gross profit as percentage of sales this measures the amount of gross profit from
ever $100 of sales

Gross Profit x 100
Sales

The gross profit as a percentage of sales and rate of stock turnover ratios are ratios that
measures the profitability of a business.

Example 4.1

A business’s trading account include the following information

Trading Account
For the year ended 31 December 2010

$ $ $
Sales 240,000
194,000
Less Closing Stock 14,000 180,000
Gross Profit 60,000


Margin Gross Profit x 100 60,000 x 100 25%
Selling Price 240,000

Mark-up Gross Profit x 100 60,000 x 100 33 1/3 %
Cost Price 180,000

Rate of Stock Cost of goods sold 180,000 12 times
Turnover Average stock 15,000

Gross Profit as a Gross Profit x 60,000 25 %
percentage of Sales 100 240,000
Sales

PROFIT AND LOSS ACCOUNT RATIOS
Accounting ratios classified as profit and loss account ratios are

1. Net profit as a percentage of sales this shows how much net profit has been made
for every $100 of sales.

Net Profit x 100
Sales

This ratio takes into account the expenses incurred and shows the amount of profit
remaining. Changes in this ratio can be linked to

Changes in the gross profit/sales percentage
Changes in the expenses.

2. Expenses to sales ratio

Expenses x 100
Sale


Example 4.2

A business’s total sales for the year ended 31 December 2010 was $400,000. Its Profit and
Loss included the following information.
$ $ $
Gross Profit 140,000
General expenses 24,000
Wages 82,000 106,000
Profit 34,000

Net Profit as Net Profit x 100 34,000 x 100
Percentage of sales Sales 400,000 8.5%

Expenses as Expenses x 100
Percentage of Sales Sales 106,000 x 100 26.5%
400,000

BALANCE SHEET RATIOS
Manager uses different information to determine the performance of the business. The
ratios that analyse the balance sheet are

1. Current ratio
Current Assets
Current Liabilities

This shows the relationship between the current assets and the current liabilities. It
determines the amount of money the business has to pay its debts as they become due.
The ability of a business to pay its debts when they become due is called liquidity. The
business will have liquidity problems if this ratio is below 2:1.

2. Acid Test Ratio

Current Assets – Stock
Current Liabilities

The acid test ratio also measures the liquidity of a business since it measures the amount of
liquid assets it has to pay its current liabilities

3. Return on Capital Employed

Profit x 100
Capital Invested

This ratio compares the amount of profit made in relation to the amount of money invested
into the business.


4. Debtors Ratio

Debtors x 12
Sales

The debtor’s ratio measures how long the debtors take to pay what they owe to the
business.

5. Creditors Ratio

Creditors x 12
Purchases

This measures how long it takes the business to pay the debts owed to its suppliers within a
year.

Example 4.3

J. Richardson Retail Store Balance Sheet as at 31 December 2011 is as follows:

J. Richardson Retail Store
Balance Sheet
As at 31 December 2011

Fixed Assets $ $
Equipment at cost 10,000
Less Depreciation to date 8,000 2,000

Current Assets
Stock 15,000
Debtors 25,000
Bank 5,000
45,000
Less Current Liabilities
Creditors 5,000 40,000
42,000

Financed by:
Capital 38,000
Add Net Profit 10,000
48,000
Less Drawings 6,000
42,000
The following information is also available
Sales $80,000
Purchases $50,000
Net Profit $10,000


Current ratio Current Assets 45,000 9:1
Current liabilities 5,000

Current Assets – Stock 30,000 6:1
Acid Test Ratio Current Liabilities 5,000

Profit x 100 10,000 x 100 25%
Return on Capital Invested (38,000 + 42,000)÷2
Capital
Employed
Debtors Ratio Debtors x 12 25,000 x 12 3.75
Sales 80,000 months

Creditors Ratio Creditors x 12 5,000 x 12 1.2
Purchases 50,000 months

TOPIC SUMMARY
You have completed the examination of your financial records with the use of accounting
ratios. You would have learnt that ratios shows and identifies different performances of
your business. You can now compare how your business performs from one period to the
next and with similar businesses. They inform you and guide you to make necessary
changes to improve your business performance.


TOPIC 4.2 CORRECTION OF ERRORS
INTRODUCTION
A Trial Balance is drawn up at the end of the accounting period using the balances on each
account in the ledgers. Even thought the trial balance totals may agree there are instances
where errors may be made in the recording of accounting entries. In this topic you will look
at those errors that may occur that do not affect the trial balance and agreement and how
these errors are corrected. We will also look at those errors that will affect the agreement
of the trial balance totals and how to correct these errors.

OBJECTIVES

1. understand that there are two types of errors;
2. appreciate that errors are identified after a period of time;
3. distinguish between the different types of errors; and
4. use the journals to correct errors.

TYPES OF ERRORS
There are two types of errors.

1. Those that affect the trial balance totals agreement.
2. Those that don’t affect the trial balance agreement.

Whenever these errors are identified they are corrected by using the journal. You have
learnt how the trial balance is used to check the arithmetic accuracy of the financial
records. You will how learn that not all errors are revealed in the trial balance. We will now
look at these errors in more detail


Errors that don’t affect the trial balance agreement

Your trail balance can still balance even though errors were made in your records. These
errors are

1. Errors of Commission – this occurs when the correct amount is entered in the records
but in the wrong persons account.

Example

V. Peters paid us $150 by Cheque on 7th September 2011. This is correctly entered in
the cash book, but was entered by error in A. Peters. The error was found on 30
September 2011. This will now have to be corrected and requires two entries

Debit A Peters’ Account To cancel out the error on the credit side of that account
Credit V Peters Account To enter the amount in the correct account
A Peters
2011 $ 2011 $
Sept 31 V Peters: Error Corrected 150 Sept 7 Bank 150

V. Peters
2011 $ 2011 $
Sept 1 Balance b/d 150 Sept 31 Cash entered in error
In A. Peters account 150


2. Errors of Principle – occurs when an item is entered in the wrong type of account. Eg.
A fixed asset entered in an expense account.

Example

You purchase motor car for $6,700 by cheque on 12 September 2011 has been debited in
error to the motor expenses account. In the cash book it is shown correctly. This means
that there has been both a debit of $6,700 and a credit of $6,700.

The error is detected on 30 September 2011 and is corrected. To do so two entries are
needed;
Debit Motor Car Account to put the amount in the correct account
Credit Motor Expenses to cancel the error previously made in the motor
expenses account

Motor Expenses
2011 $ 2011 $
Sept 12 Bank 6,700 Sept 30 motor car (error corrected) 6,700

Motor Car
2011 $ 2011 $
Sept 30 Bank (error corrected) 6,7000

3. Error of Omission – occurs when a transactions has been completely omitted from the
books

Example

You sold goods to P. Jackson for $250 on 7th September 2011 but did not enter the
transaction in the accounts. There were no debit and credit entries made. The error
was identified on 30 September. The entries to correct it will be thus:
Sales
2011 $ 2011 $
Sept 30 P. Jackson 250

P. Jackson
2011 $ 2011 $
Sept 30 Sales 250


4. Error of Original Entry – occurs when an item is entered, but both debit and credit
entries are of the same incorrect amount.

Example

Purchases of $150 to T Henry on 13 September 2011 have been entered as both a debit
and credit of $125. The account would appear thus:
T. Henry
2011 $ 2011 $
Sept 13 Purchases 125

Purchases
2011 $ 2011 $
Sept 13 T Henry 125

The error is found 30 September 2011, The entries to correct is are now shown:

T. Henry
2011 $ 2011 $
Sept 13 Purchases 125
Sept 30 purchases (error corrected) 25

Purchases
2011 $ 2011 $
Sept 13 T Henry 125
Sept 30 T. Henry (error corrected) 25


5. Compensating Errors – where two or more unrelated errors cancel each other out.

Example

In a case where incorrect totals has purchases of $7,900 and sales of $9,900. The
purchases day book adds up to be $200 too much. In the same period, the sales day
book also adds up to be $200 too much.

If these were the only errors in your books, the trial balance totals would equal each
other. Both totals would be wrong – they would both be $200 too much- but they
would equal. In this case, the accounts would have appeared as follows:

Sales
2011 $ 2011 $
Sept 13 Total sales 9,900

Purchases
2011 $ 2011 $
Sept 13 Total Purchases 7,900

When corrected, the accounts will appear as:

Sales
2011 $ 2011 $
Sept 30 Journal (error corrected) 200 Sept 13 Total sales 9,900

Purchases
2011 $ 2011 $
Sept 13 Total Purchases 7,900 Sept 30 Journal (error corrected) 200

The Journal entries to correct these two errors will be
Journal
2011 DR CR
$ $
Sept 30 Sales 200
Purchases 200
Correction of compensating error


Errors that affect the trial balance agreement

These errors will cause a difference in the trial balance totals. These errors are

1. Under-casting and over-casting – figures that are larger or smaller than they should
be.
2. Transposition – that is figures turned around eg. 23 instead of 32
3. Entries made on the wrong side of accounts – that is a debit entry made instead of a
credit entry.
4. Half the double entry omitted – only one part of the double entry completed

When there is difference in the trial balance, the amount is transferred to the suspense
account on the same side as the difference in the trial balance. A suspense account is
opened to record the difference in the trial balance totals. When the errors are located
they are first recorded in the journal and the correction is recorded in the suspense
account.

In order to correct these errors several entries are needed to make a correction, first
entries to cancel the original entry which is wrong and second the entries that should have
been made in the first place.

Example
Your Trial Balance on 31 December 2010 shows a difference of $350. It was a shortage on
credit side. A suspense account is opened and the difference of $350 is entered on the
credit side.

On 30 September 2011 the error is found. You had received payment of $350 from V.
Peters to close her account. It was correctly entered in the cash book, but it was not
entered in V. Peters’ account.

To correct the error, the account of V. Peters is credited with $350, as it should have been
2010, and the suspense account is debited with $350 so that the account can be closed.

V. Peters
2011 $ 2011 $
Jan 1 Balance b/d 350 Sept 30 Bank 350

Suspense Account
2011 $ 2010 $
Sept 30 V. Peters 350 Dec 31 Difference per trial balance 350


Journal
2011 DR CR
$ $
Sept 30 Suspense Account 350
V. Peters 350
Correction of non-entry of payment made by
V. Peters account

TOPIC SUMMARY
You would have learnt that all errors cannot be identified from simply looking at your
records. You would also learnt that all errors do not affect your Trial Balance total. Some
errors are only identified after careful examination of your books.

You would also realize that an error has occurred once the trial balance totals doesn’t
agree. When this happens the difference on the trial balance is transferred to a suspense
account. Once the error is identified it is corrected through the Journal and then the
suspense account.


TOPIC 4.3 PAYROLL
INTRODUCTION
With any business with employees one of its major expenses are the payment of wages
and/or salaries to its workers. In this section we will look at how wages and salaries are
calculated and their various deductions

OBJECTIVES

1. Understand the function of the payroll.
2. Use various methods to calculate salaries.
3. Identify the difference between statutory and non-statutory deductions.
4. Complete the payroll and wage documents from time cards.

Every business pays its employees’ wages and/or salaries for the labour they supply to carry
out the business activity. Wages are paid weekly or forth nightly at a rate that considers
the number of hours or number of pieces of work produced. Salaries are a fixed amount
paid monthly no matter the amount of pieces produced or hours worked.

METHODS OF CALCULATING PAY
Wages can be calculated using various methods or a combination of methods. The main
methods of calculating wages are;

Flat rate – a basic rate is based on a standard number of hours. This agreed
monthly salary or weekly wage.
Piece rate – employees are paid based on the number of units produced during the
pay period.

Example

JYPR Ltd manufactures chairs. There are several process involved in assembling the
chairs. Employees are paid the following piece rates:
Process 1: $2.00 per chair

Elrie works in the assembly department, during the week ended 30 September 2011 he
completed the following tasks:

Process 1: 20
Process 2: 40
Process 3: 30


Elrie will be paid the following

$
Process 1 20 x 2 40.00
Process 2 40 x 3 120.00
Process 3 30 x 4 120.00
Total 280.00

Time rate – is a fixed rate per hours is paid multiplied by the number of hours
worked.

Example

Ann works part-time at a supermarket. Ann is pay $24 per hour. During the week ended
30 September 2011, Ann was employed for 17 hours.
Ann will be paid a wage of 17 hours x $24 = $408

Overtime rate – any hours worked above the regular standard working hours are
paid at a higher rate. Overtime rates can be charged as one and half, two times and
three times the regular rates.

Example

Catina is paid $30 per hour working in a restaurant. Catina is contracted to work 35
hours per week. During the week ended 23 September 2011, she worked 39 hours.
Overtime is paid at time and a half.

Catina will be paid 35 hours x $30 per week = $1,050 per week
During the week ended 23 September 2011, she will be paid $1,050 plus overtime

Overtime payment = 4 hours x ($30 x 1.5) = 4 hours x $45 = $180

Wage for the week ended 23th September is $1,230


Commission – is based on the amount of sales made by the employee. It could be
paid in addition to the basic salary or instead of a salary. It is normally calculated as
a percentage of the employee’s sale.

Example

Ulrick works in a department store. He is paid $3 000 per month, but is also entitled to a
commission of 1.5% based on his department’s monthly sales. His department’s
monthly sales were.
$
August 2011 32 000
September 2011 27 400

Ulrick will be paid as follows

Basic Salary Commission Total
$ $ $
August 2011 3,000 1.5% x $32,000 = $480 3,480
September 2011 3,000 1.5% x 27,400 = $411 3,411

CALCULATING EMPLOYEES EARNINGS
Each employee receives a pay slip at the end of their pay period. A pay slip shows the
calculation of the employees’ gross pay their deductions and their net pay. Gross pay is the
amount due to the employees at the end of their pay period for the work done before any
deductions. Once the gross pay is calculated there are some statutory and non statuary
deductions that must be deducted before we arrive at the net pay.

Statutory deductions are those deductions that are required by law. These deductions
includes

1. Income tax – many countries have a tax system known as the Pay As You Earn
(PAYE). The amount paid in tax increases the higher your gross pay is. However
most system allows a part of the gross to be exempt from tax (tax fee allowance)
any amount above that allowance would be taxable
2. National Insurance or Social Security contributions – this deduction is paid to
provide funds to provide income to workers during illness, injury, retirement etc.
3. Pension Plan contribution – some employers require employees to contribute to a
scheme that will ensure that when they retire they are entitled to receive a pension
from their employers as well from the state.


Non-statutory deductions as those deductions that employees may request be made to
meet their personal needs. Examples of non-statutory deductions are:

Membership fees to clubs.
Membership to union (union dues).
Health insurance.
Life insurance.
Contribution to credit unions.

SOURCE DOCUMENTS TO CALCULATE PAYROLL
The information to calculate the employees earning are derived from various documents:

Personal Record Card – this includes information about the employees. This
information includes the employee’s correct name, address, contact number, tax
numbers and other information.
Employees Earning Records – is a history of the employees pay rates, gross pay,
deductions, net pay over a period of time.

Example

JYPR LTD
EMPLOYEE EARNING RECORD

Name__________________________________ Employee No. _____________ Position ___________

Address ________________________________ Birth Date ______________________ Sex _________

_______________________________________ Marital Status _________ No. Of Dependents _______

Tel. No. ________________________________ NIS # ________________ Starting Date ____________

ACCUMULATED
PERIOD OR YEAR TO NAT. INCOME LIFE CREDIT TOTAL NET
ENDED DATE EARNINGS REGULAR OVERTIME GROSS INS. TAX INS. UNION DEDUC. PAY
$ $ $ $ $ $ $ $ $ $


Time Card – shows the number of hours worked by the employees. It is used to
calculate the total house worked during the period. They are used to clock in and
out of the work place.

Example
JYPR LTD
TIME CARD
Employee’s Name: J. Jackson Work Period: Sept 21 to Sept 27 .

Employee;s Number: 09234 Department: Sales .

AM PM
DAY
IN OUT IN OUT
Sunday 21 September 7:50 12:02
Monday 22 September 6:50 12:06 12:55 4:01
Tuesday 23 September 6:55 12:05 12:59 4:02
Wednesday 24 September 6:57 12:05 12:58 7:05
Thursday 25 September 6:52 12:03 12:55 7:00
Friday 26 September 6:59 12:02 12:58 4:01
Saturday 27 September 7:55 12:02

Time Sheet – are used by employees to record the overall attendance of the
employees.

Example
JYPR LTD
TIME SHEET

Employee’s Name: J. Jackson Work Period: Sept 21 to Sept 27 .
Employee’s Number: 09234 Department: Sales .

AM PM Regular Overtime Total
DAY
IN OUT IN OUT Hours Hours Hours
Sunday 21 Sept. 7:50 12:02 - 4 4
Monday 22 Sept. 6:50 12:06 12:55 4:01 8 - 8
Tuesday 23 Sept. 6:55 12:05 12:59 4:02 8 - 8
Wednesday 24
6:57 12:05 12:58 7:05 8 3 11
Sept.
Thursday 25 Sept. 6:52 12:03 12:55 7:00 8 3 11
Friday 26 Sept. 6:59 12:02 12:58 4:01 8 - 8
Saturday 27 Sept. 7:55 12:02 - 4 4
Total 40 14 54


Employees’ Payroll Sheet is completed at the end of work period for all employees.

Example

If the employees of JYPR LTD regular work week is 40 hours at a rate of $30 per hour. They
received time and quarter (1 ¼) for any overtime worked during the regular work week and time
and half (1 ½) for any overtime worked on Saturdays and double time (2) for any overtime
worked on Sundays. Calculate J Jackson gross pay for the period 21 – 27 September.

Employees Payroll Register
Employee Regular Overtime Gross
Names
No. Pay Week Saturday Sunday Total Pay
J. Jackson 09234 2400 225 180 240 645 3 045

Payslip – is prepared for each employee, who receives it on “pay day”. The
information on the employee earnings record is transferred to the payslip.

Example
PAYSLIP
SEPTEMBER 27, 2011
Name Gross Income Life Credit Total Net
Nat. Ins
Pay Tax Ins. Union Deductions Pay
J. Jackson 3 045

PAYROLL
The payroll is the document that summaries for each employees. It shows all the
information used to calculate the Net Pay.

Example

With the following information calculate the net pay JYPR Ltd employees

National Insurance 2 ½ % of Gross
Income tax 15% of gross pay less credit union contribution
Life insurance 2% of gross pay
Credit union 1% of gross pay

Credit union = 1% x $3045 = 30.45
National Insurance 2 ½% x $3045 = $76.13
Income tax 15% x (3045 – 30.45) = 452.18
Life insurance 2 % x 3045 = 60.90


JYPR LTD
PAYROLL REGISTER
Accumulated Deductions
Regular Overtime Gross Net
Total or year to Nat Income Life Credit
Employees hours hours pay Total Pay
hours date Ins Tax Ins Union
$ $ $ $ $
earnings $ $ $ $
J. Jackson 54 2 400 645 3 045 3 045.00 76.13 452.18 60.90 30.45 619.70 2 423.34

TOPIC SUMMARY
It is important to note the different ways in calculating your employees’ wages and salary.
There are both statuary and non-statutory deductions that are deducted from the wages
and salaries of your employees. Statutory deductions are those deductions required by law.
Non statutory are requested by the employee.

The information for preparing the wages and salaries are taken from the time cards of the
employees. Each employee should receive a copy of their payslip which provides them with
information about their pay before deductions (gross pay) and the take home pay after
deductions (net pay).


TOPIC 4.4 BANK RECONCILIATION STATEMENT
INTRODUCTION
In this unit you will learn how to reconcile your cash book so that its balance aggress with
the balance on your bank statement

OBJECTIVES

1. Explain terms used on the bank statement.
2. Compare the cash book with the bank statement.
3. Update the cash book.
4. Prepare the bank reconciliation statement.

BANK STATEMENTS AND THE CASH BOOK
When you make or receive payment by cheques they are recorded in the bank column of
your cash book. When these cheques are presented at you bank there would be a part of
your monthly bank statement. A bank statement is a copy of the bank’s record of your
account. The balances on you bank statement is calculated after each transaction this is
the running balance of recording. Items on the debit side of the cash book (bank column)
would be recorded on the credit side of the bank statement and vice versa.

At the end of each month they would be items on your bank statement that is not recorded
in your cash book and items in the cash book not in bank statements.

Items on the bank statement that is not recorded in the cash book

1. Returned cheques (dishonoured cheques) – these are cheques that are returned by
the bank for various reasons. Reasons which include insufficient funds or word and
figures on the cheque do not agree. On it written refer to drawer.
2. Bank charges – fees that the bank charges for operating your account.
3. Interest received – from the bank.
4. Standing order – is an agreement between you and your bank for it to make
monthly payments, of fixed amount on a specific date, on your behalf.
5. Credit transfer – you may instruct your bank to pay a supplier on your behalf.

Items in the Cash Book that is not recorded on the Bank Statement

1. Unrecorded Deposits - deposits made to the bank that is not recorded on your
bank statement
2. Un-presented cheques - cheques written but has not been presented to bank for
cashing.

You can use either of two methods to reconcile your cash book with your bank statement
after revising your Cash book.


1. Begin with balance on your revise cash book the end total should be the balance on
your bank statement
2. Begin with the balance on bank statement with the end balance being the balance
on you revised cash book.

Step to reconciliation your cash book and bank statement.

1. Tick the items that are recorded on both your bank statement and your cash book
2. Revise you cash book by including the items in your bank statement that are not in
your cash book and then find the new balance for your cash book.
3. You can now use either method and complete you reconciliation.

The bank reconciliation statement would be as follows:

Name of business
Bank Reconciliation as at (date)

Balance per revised cash book
Add unpresented cheques
Less unrecorded deposits
Balance per bank statement

OR

Name of business

Balance per bank statement
Add unrecorded deposits
Less unpresented cheques
Balance per revised cash book


Let now look at an example.

Example

The following is an extract from the bank statement and cash book (bank column) of
JYPR Ltd for the month of September 2011
Cash Book (bank column only)
Sept 1 Balance 800 Sept 3 Insurance (chk 0892) 360
Sept 16 Sales 890 Sept 11 Drawings (chk 0893) 250
Sept 27 Sales 750 Sept 19 E. Peters (chk 0894) 440
Sept 27 Electricity (chk 0895) 220
Sept 31 Balance c/d 1,170
2,440 2,440
Oct 1 Balance b/d 1,170

Peters Bank Ltd
Bank Statement for JYPR Ltd
Date Details Dr Cr Balance
2011 $ $ $
Sept 1 Balance 800 Cr
Sept 5 Anjo Insurance plc (0892) 360 440 Cr
Sept 5 Direct Debit iMoble co. 230 210 Cr
Sept 14 Chk 0893 250 40 Dr
Sept 18 Sundries 890 850 Cr
Sept 21 Standing Order Aires Property Ltd 280 570 Cr
Sept 24 Credit Transfer – Ann Carter 480 1,050 Cr
Sept 27 Bank charges 80 970 Cr

The closing balance shown in two documents are different; cash book balance is $1,170,
but the bank statement shows a balance of $970.

Let begin by ticking off the items that are in both the cash book and the bank statement.
Cash Book (bank column only)
Sept 1 Balance  800 Sept 3 Insurance (chk 0892)  360
Sept 16 Sales  890 Sept 11 Drawings (chk 0893)  250
2,440 2,440


Peters Bank Ltd
Bank Statement for JYPR Ltd
Date Details Dr Cr Balance
2011 $ $ $
Sept 1 Balance 800 Cr
Sept 5 Anjo Insurance plc (0892) 360 440 Cr
Sept 5 Direct Debit iMoble co. 230 210 Cr
Sept 14 Chk 0893 250 40 Dr
Sept 18 Sundries 890 850 Cr
Sept 21 Standing Order Aires Property Ltd 280 570 Cr
Sept 24 Credit Transfer – Ann Carter 480 1,050 Cr
Sept 27 Bank charges 80 970 Cr

You will now revise or update your cash book on the 1st October 2011. This is done by
including in the cash book the items from the bank statement that are not included

Revised Cash Book (bank column only)
Sept 1 Balance 800 Sept 3 Insurance (chk 0892) 360
Sept 16 Sales 890 Sept 11 Drawings (chk 0893) 250
2,440 2,440
Oct 1 Balance b/d 1,170 Oct 1 Direct Debit iMobile co. 230
Oct 1 Credit Transfer 480 Oct 1 Standing Order 280
Oct 1 Bank charges 80
Oct 1 Balance c/d 1,060
1,650 1,650

JYPR Ltd cash book is now updated. You can now prepare the bank reconciliation
statement. To do this you include the items in the cash book that was not recorded in
the bank statement.


JYPR Ltd
Bank Reconciliation Statement as at 1st October 2011
$ $
Balance per revised cash book 1,060
Add Un-presented cheques
E. Peters (chk 0894) 440
Electricity (chk 0895) 220 660
1,720
Less unrecorded deposits 750
Balance per bank statement 970

OR

JYPR Ltd
Bank Reconciliation Statement as at 1st October 2011
$ $

Balance per bank statement 970
Add unrecorded deposits 750
1,720
Less Unpresented cheques
E. Peters (chk 0894) 440
Electricity (chk 0895) 220 660

Balance per revised cash book 1,060

There are instances where both your bank statement and your cash book may record an
overdraft. When this occurs you follow the same method to revise your cash book but your
reconciliation statement would be done as follows.

Name of business
Overdraft per revised cash book
Add un-recorded deposits
Less un-presented cheques
Overdraft per bank statement

OR

Name of business


Overdraft per bank statement
Add un-presented cheques
Less un-recorded deposit
Overdraft per revised cash book

TOPIC SUMMARY
You would have learnt that there are various reasons why the balance in your cash book
would be different from the balances on the Bank Statement. Once you have identified the
these items you then revise or update your cash book by including in your cash book those
items in your bank statement that are not in your cash book. The new total in your cash
book is reconciled with your bank statement. You reconcile by starting with either the
revised cash book balance or the bank statement balance.


TOPIC 4.5 PETTY CASH BOOK AND THE IMPREST SYSTEM
INTRODUCTION
Most business make small cash payments for goods and services in there day to day
operations. These payments are too small to incur the bank changes for writing a cheque.
This is what a petty cash system is used for making these small payments.

OBJECTIVES

1. Write up a petty cash book.
2. Understand the Imprest system.

PETTY CASH SYSTEM
The petty cash system records small payments, leaving large sum for the cash book. The
petty cash is usually kept by a junior clerk. An imprest system is used where fixed sum, or
cash float is advanced by the cashier to the petty cashier. The total of the petty payments
is refunded to the cashier at the end of the month, leaving the cashier with the same fixed
or imprest amount in hand for the petty expenses of the following months. The petty
cashier will produce the petty cash vouchers as evidence of the amount spent. The petty
cash in hand should them be equal to the original amount with which the period started.
This amount is called the “float”.

The receipt column is on the debit side of the petty cash book. On the credit side the date
and details of each payment is record. Each payment is not only recorded in the total
column but also in the analysis column. Analysis column are columns that indicate the
various expenditure headings.

In order for employees to access the petty cash, a petty cash voucher has to be completed
indicating what the funds will be used for and signed by requesting employee and approved
by a supervisor or senior cashier.


Let us look at a worked example. Below are two petty cash vouchers for the month of
October 2011 as completed by the petty cashier of JYPR Ltd.

No. 10 . No. 7 .

PETTY CASH VOUCHER PETTY CASH VOUCHER
Date 29 Oct. 2011 Date 20 Oct. 2011

Amount Amount
For what required $ For what required $

Petrol 32.00 Postage 20.00
32.00 20.00

Signature __________J. Jackson________ Signature __________V._Peters________

Approved by _____M. Richardson ___ Approved by _____M. Richardson ___

Petty cash vouchers were also completed for the following transactions.

2011 $

Oct 1 The cashier gave $600 as float to the petty cashier

Oct 2 Petrol 22

Oct 3 L. Thomas – travelling expenses 24

Oct 10 Refund C Charles sales ledger account over paid 65

Oct 12 Cleaning expenses 50

Oct 15 J Harris – travelling 75

Oct 20 settle of P Phillip’s account in the purchases ledger 35

Oct 22 petrol 30

Oct 27 Cleaning expenses 65

Oct 30 Postage 25

The petty cash book for October 2011 would be as follows:


Petty Cash Book
Voucher Cleaning Motor Travelling Ledger Ledger
Receipts Folio Date Details No. Total Expenses Expenses Expenses Postage Folio Accounts
$ 2011 $ $ $ $ $ $
600 CB 1-Oct Cash
2-Oct Petrol 1 22 22
3-Oct L Thomas 2 24 24
10-Oct C Charles 3 65 SL 65
12-Oct Cleaning expenses 4 50 50
15-Oct J Harris 5 75 75
20-Oct P Phillip 6 35 PL 35
20-Oct Postage 7 20 20
27-Oct Cleaning expenses 9 65 65
30-Oct Postage 11 25 25
443 115 84 99 45 100
31-Oct Balance c/d 157 GL GL GL GL
600 600
157 1-Nov Balance b/d
443 CB 1-Nov Cash


The information in the petty cash book is then transferred to the various ledger accounts.

Cash Book (Bank Column only)
2011 $ 2011 $
1-Oct Petty Cash PCB 600
1-Nov Petty Cash PCB 443

General Ledger
Motor Expenses
2011 $

Travelling Expenses
2011 $

Cleaning Expenses
2011 $

Postage
2011 $

Sales Ledger
C. Charles
2011 $ 2011 $
10-Oct Petty Cash PCB 65 1-Oct Balance b/d 65

Purchases Ledger
P. Phillip
2011 $ 2011 $
20-Oct Petty Cash PCB 35 1-Oct Balance b/d 35


TOPIC SUMMARY
You have just examined the petty book of a JYPR Ltd. The information recorded in the petty
cash book is derived from the petty cash vouchers which must be completed and approved
before funds can be disbursed. The petty cash funds (float) are disbursed by the petty
cashier. At the end of each period the petty cashier reimbursed the amount of the float
spent to start the new period.


TOPIC 4.6 CONTROL ACCOUNTS
INTRODUCTION
Earlier you learned that certain errors were not revealed in the trial balance. In a large
business you would have to check every item in every ledger. This is done with the control
accounts. This ensures that it is only the ledgers whose control accounts does not balance
that need detailed checking to find errors.

OBJECTIVES
Upon completion of this topic you will be able to:

1. Draw up sales ledger accounts.
2. Draw up purchase ledger accounts.
3. Know the sources of information for control accounts.

CONTROL ACCOUNT PRINCIPLES
Control accounts are based on simple principle. If the opening balance of an account is
known, together with the information on the additions and deductions entered in the
account the closing balance can be calculated. The information to draw up control accounts
are

Sales ledger control Source
Opening debtors List of debtors balances drawn up at end of
previous period
Credit sales Total from the sales journal
Return inwards Total from returns inwards journal
Cheques received Cash book bank column
Cash received Cash book cash column
Discount allowed Total of discount allowed column in the cash book
Closing debtors List of debtors’ balances drawn up at the end of
the period

Purchases Ledger Control Source
Opening creditors List of creditors balances drawn up at end of
previous period
Credit purchases Total from the purchases journal
Return outwards Total from returns outwards journal
Cheques paid Cash book bank column payments side
Cash paid Cash book cash column payment side
Discount received Total of discount received column in the cash book
Closing creditors List of creditors’ balances drawn up at the end of
the period


Control Accounts are prepared in the form as an account with the totals of the debit entries
in ledger on the left hand side of the control account, and the totals of the credit entries in
the ledger on the right hand side.

Worked Example

Ann runs a small business selling computer parts to wholesalers. Since he has numerous
debtors and creditors she keeps sales and purchases ledgers and maintains both sales and
purchases control accounts. The following information is available from Ann’s books for 31
December 2010.

2011 $
1-Dec sales ledger debit balances 4,756
1-Dec sales ledger credit balances 350
1-Dec purchases ledger credit balances 3,681
1-Dec purchases ledger debit balances 287

Totals for the month ending December 31, 2011
cash sales 6,743
bank sales 9,838
cash purchases 4,231
cheques and cash received from customers 11,742
discount allowed 618
return inwards 371
cheques paid to suppliers 6,000
petty cash paid to suppliers 120
discount received 364
return outwards 278
bad debts written off 446
cheques refunded to customers 280
Dishonoured cheques 194
sales ledger credit set-off with the
purchases ledger 335
sales ledger debit balances 2,335
purchase ledger debit balances 165
purchase ledger credit balances 4,021

Let’s look at the solution for this question.


Ann
Sales Ledger Control Account For December 2011
2011 $ 2011 $
1-Dec balance b/d 4,756 1-Dec balances b/d 350
31- 31-
Dec sales 10,967 Dec Cheques and Cash received 11,742
cheques refunded 280 discount allowed 618
dishonoured cheques 194 return inwards 371
bad debts written off 446
sales ledger credit set off 335
balances c/d 2,335
16,197 16,197
1-Jan Balance b/d 2,335

Ann
Purchases Ledger Control Account For December 2011
2011 $ 2011 $
1-Dec balance b/d 287 1-Dec balances b/d 3,681
31- 31-
Dec cheques paid 6,000 Dec Purchases 7,559
cheques refunded 120 Balances c/d 165
discount received 364
return outwards 278
sales ledger set off 335
balance c/d 4,021
11,405 11,405
1-Jan Balance b/d 165 1-Jan balance b/d 4,021


UNIT REFERENCES
Austen, D., Ellis, D., et al (2011). Principles of Accounts for CSEC.
United Kingdom, Nelson Thornes Lted.


Whitcomb, A., & Clarke, G., (202). Accounts for CSEC. United Kingdom,
Heinemann Educational Publishers

England, Pearson Education Limited


UNIT SUMMARY
In unit four you were able to use different methods to analyse and interpret the financial
statement of the business. You looked at accounting ratio that are useful to compare a
business with another or with one period to another. You also examined errors that may
occur in financial records and how to identify and correct these errors. You also looked a
payroll system, how to reconcile your cash book with your bank statement and how control
accounts are also used to identify errors in your books.


UNIT FIVE – FINANCIAL STATEMENTS OF OTHER ORGANIZATIONS

UNIT INTRODUCTION
So far we have look at the complete accounting records of a sole trader. In this unit we
would take a introductory look at the accounts of different forms of business such as non-
profit organizations, partnership and company. We will begin this unit by taking a look at
incomplete records of sole traders and how the financial positions of these can be
determined from these incomplete records.

UNIT OBJECTIVES

1. Draw up a trading and profit and loss account and balance sheet from records not kept
on a double entry system.
2. Deduce the figures of sales and purchases form incomplete records.
3. Draw up income and expenditure accounts and balance sheets for non-trading
organizations.
4. Calculate profit and losses from special activities and incorporate them into the final
accounts.
5. Determine the financial positions of these non-trading organizations.
6. Understand exactly what a partnership is.
7. What are the main features of a partnership agreement.
8. Draw up final accounts for a partnership.
9. Understand exactly how limited companies differ from other organizations.
10. Calculate how distributable profits are available for dividends are divided between the
different classes of shares.
11. Realize the differences between shares and debentures.
12. Draw up the trading and profit and loss accounts for a limited company.
13. Draw up a balance sheet for a limited company.

UNIT READINGS



TOPIC 5.1 SINGLE ENTRY AND INCOMPLETE RECORDS
TOPIC INTRODUCTION
We have been able thus far to prepare final accounts of sole traders who keeps a complete
set of records. However many small business do not keep complete records and may have
difficult determining if there business is making a profit or a loss. In this topic will look at
these incomplete records.

OBJECTIVES

1. Draw up a trading and profit and loss account and balance sheet from records not kept
on a double entry system.
2. Deduce the figures of sales and purchases form incomplete records.

RECORDS KEEPING
Many small businesses do not keep proper financial records which makes it difficult at first
glance to determine the financial position of that business. Even with these incomplete
records you are still able to determine whether or not this business is making a profit or
loss.

However there are a couple of things you must remember before you continue. Firstly
remember that profit increases capital. As you determined from the balance sheet of sole
trader

Net Profit = closing capital - Opening capital

In the balance you are able to determine this year’s capital by doing the following
calculations

Opening Capital + Profit - Drawings = closing Capital

Usually when using incomplete records you are given two year’s information to derive
information about that business. The first year’s information is used to draw up a
statement of affairs to calculate the opening capital of the business. The second year’s
information is used to determine if the business is making a profit or loss.

Let look at a worked example.

J. Anderson kept records of her business transactions in a single entry form. Her bank
account for the year 2010 is as follows:


$ $

Balance 1.1.2010 1,890 cash withdrawn from bank 5,400
Receipts from debtors 44,656 trade creditors 31,695
Loan from T. Hughes 2,000 rent 2,750
Rates 1,316
Drawings 3,095
Sundry expenses 1,642

Records of cash paid were: sundry expenses $122, trade creditors $642. Cash sales
amounted to $698; cash drawings were $5,289. The following information is also available:

31.12.2009 31.12.2010
$ $
Cash in hand 48 93
Trade creditors 4,896 5,091
Debtors 6,013 7,132
Rent owing - 250
Rates in advance 282 312
Motor van (at valuation) 2,800 2,400
Stock 11,163 13,021

We begin by calculation the capital at the end of 2009. This is done by drawing up a
Statement of Affairs as at 31 December 2009.

J. Anderson
Statement of Affairs
As at 31 December 2009
Fixed Assets $ $
Motor Van 2,800

Current assets
Stock 11,163
Debtors 6,013
Bank 1,890
Cash 48
Rates prepaid 282
19,396
Less current liabilities
Creditors 4,896 14,500
17,300 .

Financed by
Capital (difference) 17,300
17,300


You can now prepare total debtors and total creditors account. The total creditors account
will be used to calculate the purchases figure and the total debtors account to calculate the
sales figure.

Total Creditors’ Account

$ $
Cash 642 Balances b/d 4,896
Bank 31,695 Purchases (missing figures) 32,532
Balance c/d 5,091 ____________
37,428 37,428

Total Debtors’ Account

$ $
Balances b/d 6,013 Receipts: Bank 44,656
Sales (missing figure) 46,473 cash 698
Balances c/d 7,132
52,486 52,486

Cash Book
Details Cash Bank Details Cash Bank
$ $ $ $
Balance b/d 48 1,890 Cash C 5400
Receipt from debtors 44,656 Trade Creditors 642 31,695
cash sales 698 rent 2,750
Loan from Carter 2000 rates 1,316
Bank c 5,400 drawings 5,289 3,095
sundry expenses 122 1,642
Balance c/d 93 2,648
6,146 48,546 6,146 48,546


J. Anderson
Trading and Profit and Loss Account

$ $
Sales 46,473
Less cost of goods sold
43,695
Less closing stock 13,021 30,674
Gross Profit 15,799

Less Expenses
Rent (2,750 + 250) 3,000
Rates (1,315 + 282 -312) 1,286
Sundry expenses 1,764
Depreciation: Motor Van 400 6,450
Net Profit 9,349

TOPIC SUMMARY
You would have realized that you are still able to determine the profit or loss from a
business that don’t keep complete records. The basic information you are still able to
determine the profitability of a business and prepare final accounts of that business.


TOPIC 5.2 RECEIPTS AND PAYMENTS ACCOUNT
TOPIC INTRODUCTION
So far we have only look at business that aim is to make a profit. However there a
businesses and organizations whose may interest are not to make a profit but to provide a
service. We will now have a look at these not profit making businesses.

OBJECTIVES

1. Draw up income and expenditure accounts and balance sheets for non-trading
organizations.
2. Calculate profit and losses from special activities and incorporate them into the final
accounts.
3. Determine the financial positions of these non-trading organizations.

NON-PROFIT ACCOUNTS
Organizations such as schools, clubs and churches do not have trading and profit and loss
accounts drawn up as their main purpose is not trading or profit making. The final accounts
prepared for these organizations are Receipts and Payments account in place of a Cash
Book and the Income and Expenditure Account in place of the trading and profit and loss
accounts. The same rules that a apply for the preparation and use of the cash book and
trading and profit and loss account still applies to the receipt and payment accounts and
the income and expenditure accounts. There are some other differences in the terms used.

Profit Making Business Terms Non-Profit Making Organizations Terms

Trading And Profit And Loss Accounts Income And Expenditure Accounts

Net Profit Surplus Of Income Over Expenditure

Net Loss Excess Of Expenditure Over Income

Capital Accumulated Fund

Accumulated fund = Assets - Liabilities

There are instances where non-profit making organization will hold functions or activities to
make profit. A trading account for this activity will have to draw up to determine if a profit
or loss was made from the activity. That profit or loss is then transferred to the income and
expenditure account. Many non-profit organization generate income by charging there
members fees to be a part of the organization (subscriptions or membership fees), they


may also charge new members entrance fees and they may also receive donations from
other groups or organizations.

Let us look at worked example.

On 31 December 2011 the following information for the Sugar Bridge Social Club is made
available to you.

Balances on the 1st January 2011 $

Bank 3,070
Subscriptions in arrears for 2010 290
Subscription received in advance for 2009 420
Equipment 1,800

In respect of the year to 31 December 2010, the following information is given to you:

Subscription received (including 2009 arrears) 5,920
Equipment bought 700
Groundsman’s wages 2,880
Sale of lottery tickets 1,090
Receipts from discos 7,510
Disco cost – including musicians 4,970
Teams’ travelling expenses 1,220
Competition prizes bought 580
Rent of buildings 2,170
Receipt for ground hire 900
Committee expenses 690
Donations from well-wishes 1,500

Subscription due but unpaid at 31 December 2009 amounted to $370. Depreciate
equipment 10%.

We begin by drawing up the subscription account

Subscription Account
$ $
Arrears b/d 290 Received in Advance b/d 420
Income and Expenditure account 6,420 cash 5,920
Arrears c/d 370
6,710 6,710


Sugar Bridge Social Club
Receipts and Payments Account
Receipts $ Payments $
Balance b/d 3,070 Equipment 700
Subscriptions 5,920 Pay 2,880
Sale of Lottery tickets 1,090 Disco costs 4,970
Receipts from discos 7,510 travel expenses 1,220
ground hire 900 competitions prizes 580
donations 1,500 committee expenses 690
rent of buildings 2,170
balance c/d 6,780
19,990 19990

Sugar Bridge Social Club
Income and Expenditure Accounts

Income $ $
Subscriptions 6,420
Sale of lottery tickets 1,090
Receipts from discos 7,510
less cost of disco 4,970 2,540

ground hire 900
donations received 1,500
12,450
Less expenditure
Groundsman's pay 2,880
team's travelling expenses 1,220
competitions prizes 580
rent 2,170
committee's expenses 690
depreciation 250 7,790
surplus of income over expenditure 4,660


TOPIC SUMMARY
Not all businesses are trading or profit making business. Some businesses are in operation
to other as service to the community. These non-profit organizations however do keep
records of their financial transactions. Instead of a cash book they have a receipt and
payments account, instead of capital they have accumulated fund and instead of trading
and profit and loss account they have income and expenditure account.


TOPIC 5.3 PARTNERSHIP ACCOUNTS
INTRODUCTION
A partnership is formed when two or more person decide to go into business together. The
terms and conditions of the partnership should be determined by all parties before the
business venture begins. The partnership act gives guidelines on the formation and
dissolving of partnership agreement.

OBJECTIVES

1. Understand exactly what a partnership is.
2. Describe the main features of a partnership agreement.
3. Draw up final accounts for a partnership.

PARTNERSHIP AGREEMENTS
In the earlier units we had a look at sole trader businesses. However many businesses that
are set up to make a profit have more than one owner. This could be:

To raise the capital required to support business growth.
Gain the experience and abilities needed to operate the business.
Expand the product line.
Share management.

The Partnership Agreement

A partnership arrangement has the following desire outcomes.

It is formed to make a profit
It must follow the laws as laid out in the partnership act
Normally there is a minimum of two partners and a maximum of twenty partners
Each partner (except for limited partners) must pay his or her share of any debts
that the partnership cannot pay.

Unlimited liability partners can be forced to sell their private possessions to pay their share
of the debts. Limited liability partners are not liable for the debts of the business. They
have the following characteristics

1. Their liability is limited to the capital they have put in the business. They can lose
the capital but they cannot be asked for any more money
2. They are not allowed to take part in the management of the business

A partnership agreement usually contains the following information

The capital to be contributed by each partner


The ratio in which profits or losses should be shared
The rate of interest if any to be paid on capital before profits
The rate of interest if any to be charged on partner’s drawings
Salaries to be paid to partners
Arrangements for the admission a new partners
Procedures to be carried out when a partner dies or retires.

If there is not agreement in place then the partnership act states that

Profits and losses will be shared equally
There is no interest on capital
No interest is to be charged on drawings
Salaries are not allowed

Capital Accounts

The value of the partners holding in the business will consist of:

The original capital put into the business by the partner.
His or her spare of the profits, interest on capital (if any), salary (if any), less
interest on drawings (if any) and drawings themselves. This is the amount of
undrawn profits.

Each partner will have an account that contains both sets of information. The balance on
this account would fluctuate each year as drawings rarely equal profits. This is called
fluctuating Capital Account.

On the other hand, we could keep the original capital figure in an account for each partner.
These we would keep at the same figure and we would call these fixed capital accounts.
We would should the share of profits and interest on capital for each partner in a separate
account called Current Account.


Jack and Jill are in partnership, sharing profits and losses equally. The following is their trial
balance as at trial balance as at 30 June 2011.

Dr. Cr.
$ $
Building at cost 50,000
Fixtures at cost 11,000
Provision for depreciation: fixtures 3,300
Debtors 16,243
Creditors 11,150
Cash at bank 677
Stock at 30 June 2010 41,979
Sales 123,650
Purchases 85,416
Carriage outwards 1,288
Discount allowed 115
Loan interest: Williams 4,000
Office expenses 2,416
Wages 18,917
Bad debts 503
Provision for Bad debts 400
Loan from J. Williams 40,000
Capital:
Jack 35,000
Jill 29,500
Current Accounts
Jack 1,306
Jill 298
Drawings:
Jack 6,400
Jill 5,650 ___________
244,604 244,604__

Additional information for Jack and Jill.

Stock 30 June 2011; $56,340.
Expenses to be accrued: office expenses, $96; wages $200.
Depreciate fixtures 10% on reducing balance basis. Depreciate buildings $1,000.
Reduce provision for bad debts to $320.
Partnership salary: $800 Jack.
Interest on drawings $180, Jack, $120.
Interest on capital account balances at 10%.


Jack and Jill
Trading and Profit and Loss Account
for the year ended 30 June 2011
$ $ $
Sales 123,650
less cost of goods sold:
Opening stock 41,979
127,395
Less closing stock 56,340 71,055
gross profit 52,595
add reduction in Provision for bad debts 80
52,675
less expenses
Pay (18,917 + 200) 19,117
Office expenses (2,416 + 96) 2,512
Carriage outwards 1,288
Bad Debts 503
Loan interest 4,000
Depreciation: fixtures 770
buildings 1,000 1,770 29,305
Net Profit 23,370
Add Interest on drawings
Jack 180
Jill 120 300

less interest on capital:
Jack 3,500
Jill 2,950 6,450

Less Salary: Jill 800 7,250
16,420
Balance of profits shared:
Jack 8,210
Jill 8,210 16,420


Jack and Jill
Balance Sheet
as at 30 June 2011
Fixed Assets Cost Depreciation
$ $ $
Buildings 50,000 1,000 49,000
Fixtures 11,000 4,070 6,930
61,000 5,070 55,930
Current Assets
Stock 56,340
Debtors 16,243
bank 677
72,940
Less current liabilities
creditors 11,150
expenses owing 296 11,446
working capital 61,494
117,424
Less Long-term
loan from J. Williams 40,000
77,424

Financed by
capital
Jack 35,000
Jill 29,500 64,500

Current Accounts Jack Jill
Balance 1.7.2010 1306 298
Add interest on capital 3,500 2,950
Add Salary 800 -
Add balance of profits 8,210 8,210
13816 11458
Less Drawings 6,400 5,650
Less Interest on Drawings 180 120
7,236 5,688 12,924
77,424

TOPIC SUMMARY
When two or more individuals come together to do business a partnership is formed. Each
partner is required to make contribution the business’ capital. A partner can have limited
or unlimited liability but at least on partners should have unlimited liability.


TOPIC 5.4 COMPANY ACCOUNTS
TOPIC INTRODUCTION
So you have looked at the financial records for a sole trade and a partnership business. You
can examine the financial records of another form of business a company. Limited liability
companies are needed because of the disadvantages of the partnership business. A
partnership can have a maximum of twenty persons who may not be able to raise the
capital needed to fund a very large corporation. Also if a partnership falls the partners can
lose part or all of his private and business assets. Limited companies enable large
businesses to be formed and help the owners safeguard their private assets

TOPIC OBJECTIVES

1. understand exactly how limited companies differ from other organizations
2. calculate how distributable profits are available for dividends are divided between the
different classes of shares
3. realize the differences between shares and debentures
4. draw up the trading and profit and loss accounts for a limited company
5. draw up a balance sheet for a limited company

TYPE OF COMPANY ACCOUNTS
There are two types of limited companies public company and private company. A private
company must have a minimum of two and a maximum of fifty members. It must also ask
people to buy shares privately it cannot do so publicly. The public company can have at
least seven members and can have as many members as it wants. It can also advertise its
shares to the public for purchase.

The capital of a limited liability company is divided into shares. To be a member or
shareholder of a limited liability company you must purchase shares. Once the shareholder
have paid up fully for their shares their liability in limited to those shares. If the company
loses all its assets, the shareholder can only lose their shares. They cannot be forced to pay
anything of their private money in respect of the company’s losses.

An individual who purchase shares in a company is called a shareholder. A shareholder has
the right to attend general meetings of the company and vote at these meetings.
Shareholders use their vote to appoint directors who manages the business on behalf of
the shareholders. A shareholder receives a share of the profits known as a dividend.

A company is a “separate legal entity” from its members. This means that a company is not
considered to be the same as its members. A company and sue and be sued by even its
own shareholders.


TYPES OF SHARES
There are two types of shares:

Preference shares – these get an agreed percentage rate of dividend before the
ordinary shareholders.
Ordinary shareholders- receive the reminder of the total profits available after
preference share holders have received their dividend.

Preferences Shares can be further divided into:

Cumulative preference shares – these have an agreed maximum percentage
dividend. Any shortage of dividend paid in one year can be carried forward to the
next year. The arrears of cumulative preference share must be paid before
ordinary shareholders receive their dividend.
Non-cumulative preference shares – these receive a dividend up to an agreed
percentage each year. Any shortage is lost and cannot be carried forward to the
next year.

Normally preferences as 5% preference shares the percentage that is shown is the rate of
dividend that the shareholder will receive. So if a shareholder has $2000 5% preference
share then they will receive 5% x 2000 = 100 in dividend.

A company has different types of share capitals.

Authorized share capital known as nominal or registered capital. It is the total of
the share capital that the company is allowed to issue to the public.
Issued share capital is the total of the actual share capital that has been offered to
the public.
Called-up share capital is the total amount asked for on all the shares. It may be
only part of the amounts payable on each share.
Uncalled share capital is the total amount that is to be received in future but which
has not yet been asked for.
Calls in arrears the total amount for which payments have been asked for but has
not yet been paid by shareholders.
Paid up capital is the total amount of share capital that has been paid for by
shareholders.

FINAL ACCOUNTS
The trading account of a limited company is no different from that of a sole trader or a
partnership. There are some differences in the profit and loss account. There are two main
expenses that would only be found in company accounts.


Directors’ remuneration. Directors are legal employees of company appointed by
the shareholders. Their remuneration is charged to the main profit and loss
account.
Debenture interest. Debenture is the money a company receives as a loan. The
lender is paid interest at an agreed percentage this is known as the debenture
interest.

Under the profit and loss account for a company is an appropriation account. The
appropriation account shows how the net profits are to be used. The following is recorded
in the appropriation account

Credit side

Net profit from the year – this the net profit brought down from the profit and loss
account
Balance brought forward from last year – any profits that remain from the last year
is also brought forward.

Debit side

Transfer to reserves – directors may decide that some of the profits should not be
included in the calculation of how much should be paid out as dividends. These
profits are transferred to the reserve account. There may be a specific reason for
the transfer, such as a need to replace fixed assets; in this case the amount would
be transferred to a fixed assets replacement reserve. Or the reason may not be
specific; in this case an amount would be transferred to a general reserve account.
Amounts written off as goodwill.
Amounts written off as preliminary expenses. When a company is formed there are
many kinds of expenses concerned with its formation e.g. legal expense and various
government taxes.
Taxation payable on profits.
Dividends out of the remainder of the profits.
Balance carried forward to the next year.


Worked Example

C. Black Ltd has an authorized share capital of 90,000 ordinary shares of $1 each and 10,000
10% preference shares of $1 each. The company’s trial balance extracted after one year of
trading was as follows on 31 December 2011.

$
Net profit for 31 December 2011 11,340
Debentures 30,000
issued ordinary share capital, fully paid 60,000
issued preference share capital, fully paid 10,000
creditors 3,550
debtors 4,120
cash 2,160
stock 8,800
provision for bad debts 350
provision for depreciation: equipment 4,500
Equipment at cost 45,000
bank (use missing figure) ?

The directors decide to transfer $1,500 to the general reserve and to recommend a
dividend of 12 ½ % on the ordinary shares. The preference dividend was not paid in until
after January 2012

C. Black Ltd
Appropriation Account
$ $
Net Profit b/d 11,340
Less Appropriation
transfer to general reserve 1,500
preference dividend 10% 1,000
Proposed ordinary dividend 12 1/2 % 7,500 10,000
retained profits carried forward 1,340


C. Black Ltd
Balance Sheet
Fixed Assets $ $ $
equipment at cost 45,000
less Depreciation 4,500 40,500
90,500
Current Assets
Stock 8,000
Debtors 4,120
less provision 350 3,770
bank 9,660
cash 2,160
23,590
less current liabilities
creditors 3,550
Proposed dividends 8,500 12,050 12,340
102,840
less long-term liability
Debentures 30,000
72,840
Financed by
share capital
Authorized 100,000
Issued:
60,000 ordinary shares $1 60,000
60,000 preference shares $1 10,000 70,000

Reserves
General reserve 1,500
Retained profits 1,340 2,840
72,840

TOPIC SUMMARY
You have completed your examination of the final accounts of Limited Liability Company.
Be sure to take not of the difference in their final accounts to the final accounts of sole
trader and partnership businesses. Remember that a company raises capital by offer shares
individuals. Shareholders will in turn receive dividend on the amount of shares that they
purchase


UNIT REFERENCES
Austen, D., Ellis, D., et al (2011). Principles of Accounts for CSEC.
United Kingdom, Nelson Thornes Lted.


Whitcomb, A., & Clarke, G., (202). Accounts for CSEC. United Kingdom,
Heinemann Educational Publishers

England, Pearson Education Limited


UNIT SUMMARY
Throughout this unit you were introduced of different forms of business and the financial
records of these businesses. You should be able to identify the difference between a sole
trader, partnership and company. You should also be able to identify how each form of
business raises its capital. As you move along in your studies you would come upon
complicated forms of these financial records. However before you move along be sure that
you are able to master the information provided in this unit.


FINAL ASSIGNMENT/PROJECT
The final assignment/project will be provided by your instructor. The ideal project is should
be based on the following.

Ideally the final project for this course will require you to prepare final accounts for a sole
trader from a list of transaction and source documents. The course has been designed to
provide your guidance and activities that will prepare you to complete the final project
assigned by your instructor.

The instructor should post final project instructions here.


COURSE SUMMARY
This course has provided the entrepreneur the basic accounting principles and practices to
manage the day to day finances of a small business. The ideal business environment is one
where the entrepreneur works with a bookkeeper and account to effectively manage the
financial activities of the company. The second course in the diploma programme will add
to your knowledge of financial management and provide guidance on how to effectively
create, implement and manage a small business financial plan that allows the business to
grow and succeed in accordance with the company’s strategic plan.


Introduction to Business Accounting

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